second edition update

second edition update
Texas
LAW OF
CONTRACTS
SECOND EDITION UPDATE
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This publication is designed to provide accurate and authoritative information in regard
to the subject matter covered. It is sold with the understanding that the publisher is not
engaged in rendering legal, accounting, or other professional advice. If legal advice or
other expert assistance is required, the services of a competent professional should be
sought.
President: Dr. Andrew Temte
Executive Director, Real Estate Education: Melissa Kleeman-Moy
Development Editor: Jennifer Brandt
TEXAS LAW OF CONTRACTS SECOND EDITION UPDATE
©2016 Kaplan, Inc.
Published by DF Institute, Inc., d/b/a Kaplan Real Estate Education
332 Front St. S., Suite 501
La Crosse, WI 54601
All rights reserved. The text of this publication, or any part thereof, may not be
reproduced in any manner whatsoever without written permission from the publisher.
Printed in the United States of America
ISBN: 978-1-4754-4340-0
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Contents
Acknowledgments vi
UNIT
1
Texas Contract Law 1
Key Terms 1
Texas Real Estate License Act Unauthorized Practice of Law The Broker-Lawyer Committee Use of Promulgated Forms 4
Deceptive Trade Practices Act Summary 15
Unit 1 Review Questions 15
UNIT
2
2
3
14
2
Basics of Real Estate Law 17
Key Terms 18
Real Property and the Law 18
Land, Real Estate, and Real Property 18
Real Property vs. Personal Property 22
Characteristics of Real Property 26
Forms of Real Estate Ownership 27
Ownership of Real Estate by Business Organizations 32
Condominiums, Cooperatives, Town Houses, and Time-Shares 33
Laws Affecting Real Estate 36
Summary 37
Unit 2 Review Questions 40
UNIT
3
Contracts Used in Real Estate 42
Key Terms 43
Real Estate Contracts 43
Contract Law 43
Discharge of Contracts 47
Contracts Used in the Real Estate Business 49
Listing Agreements 50
Buyer Agency Agreements 55
Leasing Real Estate 55
Leasehold Estates 56
Lease Agreements 57
Types of Leases 60
Discharge of Leases 61
Options 61
Sales Contracts 62
Summary 62
Unit 3 Review Questions 64
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iii
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iv
Contents
UNIT
4
Ownership Rights and Limitations 66
Key Terms 67
Interests in Real Estate 67
Governmental Powers 67
Estates in Land 68
Homestead in Texas 71
Encumbrances 71
Water Rights 75
Environmental Issues 77
Summary 79
Unit 4 Review Questions 81
UNIT
5
The Sales Contract 83
Key Terms 83
Introduction 84
The Process 84
The Document 97
Financing Information 104
Disclosures 105
Conveyance of the Property 106
Contingencies 106
Signatures 106
Addenda and Amendments 106
Default and Breach Remedies 107
Summary 109
Unit 5 Review Questions 110
UNIT
6
Contingencies, Addenda, and Amendments 112
Key Terms 112
Introduction 113
Contingencies 113
Amendment 121
Addendum 124
Summary 126
Unit 6 Review Questions 127
UNIT
7
Financing Real Estate 129
Key Terms 130
Introduction 130
Mortgage Law 131
Security and Debt 131
Promissory Note 131
Mortgages or Deeds of Trust 133
Provisions of Land Contracts and Owner Financing 136
Foreclosure 136
The Real Estate Financing Market 138
Financing Techniques 140
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Contents
v
Loan Programs 144
Financing Legislation 148
Computerized Loan Origination (CLO) 149
Summary 149
Unit 7 Review Questions 152
UNIT
8
Conveyance of Title 154
Key Terms 155
Introduction 155
Title 155
Voluntary Alienation 155
Involuntary Alienation 162
Conveyance of a Decedent’s Property 164
Public Records 166
Proof of Ownership 169
Summary 171
Unit 8 Review Questions 173
UNIT
9
Transaction Process and Closing 175
Key Terms 176
Introduction 176
Transaction Process 176
Loan Approval 177
Inspections 193
Title Work 194
Preparation for Closing 194
Sample Checklist 202
Conducting the Closing 203
Real Estate Settlement Procedures Act (RESPA) 207
Prorations 210
Summary 211
Unit 9 Review Questions 213
UNIT
10
Common Contract Mistakes 215
Introduction 215
Contract Examples 216
Common Areas of Concern 219
Summary 221
Unit 10 Review Questions 221
Glossary 223
Answer Key for Unit Review Questions 235
Index 241
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Acknowledgments
We would like to thank Leonard Thomas, contributing editor, for his efforts in
revising this new edition of Texas Law of Contracts, as well as Peggy Santmyer,
contributing editor, for her work updating this second edition update. We would
also like to thank Doris Barrell, contributing author, for her work on the first
edition.
vi
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1
U N I T
■■
LEARNING OBJECTIVES
Texas Contract Law
When you have completed this unit, you will be able to
■■ describe the composition and duties of the Texas Real Estate Commission
■■
■■
■■
■■
■■
■■
■■
■■
■■
(TREC);
describe the unauthorized practice of law and how to avoid it;
describe the composition and duties of the Broker-Lawyer Committee;
describe TREC’s rules regarding the use of promulgated forms;
explain and give examples of the exceptions to TREC’s rules regarding the
use of promulgated forms;
describe the requirement by Section 5.008 of the Texas Property Code for
sellers to provide to buyers a written notice of a property’s condition;
identify the exceptions to the seller’s disclosure requirement;
explain when the seller has to provide the disclosure;
describe the buyer’s rights based upon the receipt of the disclosure; and
describe how the Deceptive Trade Practices Act applies to real estate
agents.
KEY TERMS
Broker-Lawyer Committee
Deceptive Trade Practices
Act (DTPA)
promulgate
Texas Real Estate
Commission (TREC)
Texas Real Estate License
Act (TRELA)
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Texas Law of Contracts Second Edition Update
TEXAS REAL ESTATE LICENSE ACT
Real estate agents in Texas were first licensed through the Securities Division of
the Secretary of State’s office, beginning in 1939 with passage of the Real Estate
Dealers License Act (House Bill 17, 46th Legislature, Regular Session).
In 1949, the Texas Real Estate Commission (TREC) was created to administer
the act (Senate Bill 28, 51st Legislature, Regular Session).
The act’s name was changed to the Texas Real Estate License Act (TRELA)
in 1955. The purpose of TRELA is to protect the public through regulation of
licensed real estate brokerage practitioners, real estate inspectors, residential service companies, and entities offering timeshare interests.
The policy-making body of the Texas Real Estate Commission is a nine-member
commission appointed by the governor with the advice and consent of the senate
for overlapping six-year terms. Six members must be active in real estate as fulltime brokers for five years immediately preceding appointment. Three members
must not be licensed by the commission and have no financial interest in real
estate, except as consumers.
The commission has rule-making authority, and the rules of the commission have
the full force and effect of law. That authority is established in the part of TRELA
that is reproduced in the following:
Sec. 1101.155. RULES RELATING TO CONTRACT FORMS.
(a) The commission may adopt rules in the public’s best interest that
require license holders to use contract forms prepared by the Texas Real
Estate Broker-Lawyer Committee and adopted by the commission.
(b) The commission may not prohibit a license holder from using for
the sale, exchange, option, or lease of an interest in real property a contract
form that is:
(1) prepared by the property owner; or
(2) prepared by an attorney and required by the property owner.
(c) A listing contract form adopted by the commission that relates to the
contractual obligations between a seller of real estate and a license holder
acting as an agent for the seller must include:
(1) a provision informing the parties to the contract that real estate
commissions are negotiable; and
(2) a provision explaining the availability of Texas coastal natural
hazards information important to coastal residents, if that information is
appropriate.
Before engaging in the business of completing any contract forms that bind the
sale, lease, temporary lease, or rental of any real property, the licensee should
become thoroughly familiar with what the rules do and do not permit.
UNAUTHORIZED PRACTICE OF LAW
TRELA specifically prohibits licensees from practicing law by giving opinions or
counsel regarding the validity or legal sufficiency of an instrument that addresses
real property rights or as to the status of title to real estate. Throughout the act, it
is clearly established that, prior to signing a purchase contract, the licensee must
give a buyer written advice to have the abstract covering the property examined
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Unit 1 Texas Contract Law
3
by an attorney of the buyer’s selection or to obtain an owner’s title insurance
policy prior to closing. Failure to do so may result in disciplinary action by TREC.
Licensees who choose to become REALTORS® subscribe to a REALTOR® Code
of Ethics that demands a very high level of professional conduct. The National
Association of REALTORS® Code of Ethics advises against the unauthorized
practice of law. Again, licensees are to advise their clients/customers to seek an
attorney’s advice for matters that require it.
TRELA clearly establishes that it is illegal for the licensee to draw a deed, note,
deed of trust, will, or other written instrument that transfers or may transfer an
interest in or title to real property. However, the act goes on to give permission for
a licensee to complete a contract form that may bind the sale, exchange, option,
lease, or rental of any interest in real property as long as the forms used have been
prepared by or are required by the property owner or have been provided by the
real estate commission, prepared by an attorney licensed by the State of Texas,
and approved by that attorney for a particular type of transaction. The applicable
law is as follows:
Sec. 1101.654. SUSPENSION OR REVOCATION OF LICENSE
OR CERTIFICATE FOR UNAUTHORIZED PRACTICE OF LAW.
(a) The commission shall suspend or revoke the license or certificate
of registration of a license or certificate holder who is not a licensed attorney in this state and who, for consideration, a reward, or in a pecuniary
benefit, present or anticipated, direct or indirect, or in connection with the
person’s employment, agency, or fiduciary relationship as a license or certificate holder:
(1) drafts an instrument, other than a form described by Section
1101.155, that transfers or otherwise affects an interest in real property; or
(2) advises a person regarding the validity or legal sufficiency of an
instrument or the validity of title to real property.
(b) Notwithstanding any other law, a license or certificate holder who
completes a contract form for the sale, exchange, option, or lease of an
interest in real property incidental to acting as a broker is not engaged in the
unauthorized or illegal practice of law in this state if the form was:
(1) adopted by the commission for the type of transaction for which
the form is used;
(2) prepared by an attorney licensed in this state and approved by
the attorney for the type of transaction for which the form is used; or
(3) prepared by the property owner or by an attorney and required
by the property owner.
The licensee is free to explain to the principals the meaning of the factual statements or business details contained in the contracts as long as no legal advice is
offered or given.
THE BROKER-LAWYER COMMITTEE
One of the advisory committees that exists under the statutes of TRELA is the
Broker-Lawyer Committee.
The committee is composed of six Real Estate Commission appointees (who are
licensed real estate brokers), six lawyers appointed by the president of the State
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4
Texas Law of Contracts Second Edition Update
Bar of Texas, and one public member, appointed by the governor. They serve staggered six-year terms.
The Broker-Lawyer Committee drafts and revises contract forms for use by real
estate licensees. The purpose is to expedite real estate transactions and reduce
controversies while protecting the interests of the parties involved.
This Broker-Lawyer Committee does not promulgate, or publish, forms for mandatory use by licensees; only TREC has been given rule-making authority. The
Broker-Lawyer Committee develops forms and recommends their adoption, but it
is TREC that promulgates the forms for mandatory use. The act clearly establishes
the membership in and responsibilities of the committee. Carefully review the
following text of the act:
SUBCHAPTER F
TEXAS REAL ESTATE BROKER-LAWYER COMMITTEE
Sec. 1101.251. DEFINITION OF COMMITTEE. In this subchapter, “committee” means the Texas Real Estate Broker-Lawyer Committee.
Sec. 1101.252. COMMITTEE MEMBERSHIP.
(a) The Texas Real Estate Broker-Lawyer Committee consists of 13
members appointed as follows:
(1) six members appointed by the commission;
(2) six members of the State Bar of Texas appointed by the president
of the state bar; and
(3) one public member appointed by the governor.
(b) Appointments to the committee shall be made without regard to the
race, creed, sex, religion, or national origin of the appointee.
Sec. 1101.254. POWERS AND DUTIES.
(a) In addition to other delegated powers and duties, the committee
shall draft and revise contract forms that are capable of being standardized
to expedite real estate transactions and minimize controversy.
(b) The contract forms must contain safeguards adequate to protect the
principals in the transaction.
USE OF PROMULGATED FORMS
TREC rule 537.11 addresses the use of standardized forms and lists the forms that
are currently promulgated (published), for mandatory use by a licensee when the
form fits a particular transaction.
The promulgated forms available through TREC are listed below. The forms
change regularly; visit www.trec.state.tx.us/formslawscontracts/forms/formscontracts.asp for information about current forms, including the date the form
was promulgated and the current version number of the form. Earlier versions of
forms may not be used; to do so could be considered the unauthorized practice of
law, an illegal act. The version number (form number) of the form is included in
the bottom-right corner of each page of the form (see Figure 1.1). Pay attention to
the form numbers. In addition to providing version control, it’s possible you might
hear a form called by its number instead of its name (e.g., 20-12 instead of One to
Four Family Residential Contract).
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Unit 1 Texas Contract Law
5
FIGURE 1.1: One to Four Family Residential Contract
Contract Concerning
EQUAL HOUSING
OPPORTUNITY
Page of 9
(Address
of Property)
PROMULGATED BY THE
TEXAS
REAL ESTATE COMMISSION (TREC)
4-28-2014
ONE TO FOUR FAMILY RESIDENTIAL CONTRACT (RESALE)
NOTICE: Not For Use For Condominium Transactions
1. PARTIES: The parties to this contract are
(Seller) and
(Buyer).
Seller agrees to sell and convey to Buyer and Buyer agrees to buy from Seller the Property defined
below.
2. PROPERTY: The land, improvements and accessories are collectively referred to as the “Property”.
A. LAND: Lot
Block
,
Addition, City of
, County of
,
Texas, known as
(address/zip code), or as described on attached exhibit.
B. IMPROVEMENTS: The house, garage and all other fixtures and improvements attached to the
above-described real property, including without limitation, the following permanently installed
and built-in items, if any: all equipment and appliances, valances, screens, shutters, awnings,
wall-to-wall carpeting, mirrors, ceiling fans, attic fans, mail boxes, television antennas, mounts
and brackets for televisions and speakers, heating and air-conditioning units, security and fire
detection equipment, wiring, plumbing and lighting fixtures, chandeliers, water softener system,
kitchen equipment, garage door openers, cleaning equipment, shrubbery, landscaping, outdoor
cooking equipment, and all other property owned by Seller and attached to the above described
real property.
C. ACCESSORIES: The following described related accessories, if any: window air conditioning units,
stove, fireplace screens, curtains and rods, blinds, window shades, draperies and rods, door keys,
mailbox keys, above ground pool, swimming pool equipment and maintenance accessories,
artificial fireplace logs, and controls for: (i) garage doors, (ii) entry gates, and (iii) other
improvements and accessories.
D. EXCLUSIONS: The following improvements and accessories will be retained by Seller and must
be removed prior to delivery of possession:
.
3. SALES PRICE:
A. Cash portion of Sales Price payable by Buyer at closing .............................. $
B. Sum of all financing described below (excluding any loan funding
fee or mortgage insurance premium) ...................................................... $
C. Sales Price (Sum of A and B) ................................................................... $
4. FINANCING (Not for use with reverse mortgage financing): The portion of Sales Price not
payable in cash will be paid as follows: (Check applicable boxes below)
 A.THIRD PARTY FINANCING: One or more third party mortgage loans in the total amount of
$_______
(excluding any loan funding fee or mortgage insurance premium).
(1) Property Approval: If the Property does not satisfy the lenders' underwriting requirements for
the loan(s) (including, but not limited to appraisal, insurability and lender required repairs),
Buyer may terminate this contract by giving notice to Seller prior to closing and the earnest
money will be refunded to Buyer.
(2) Credit Approval: (Check one box only)
 (a) This contract is subject to Buyer being approved for the financing described in the attached
Third Party Financing Addendum for Credit Approval.
 (b) This contract is not subject to Buyer being approved for financing and does not involve FHA
or VA financing.
 B. ASSUMPTION: The assumption of the unpaid principal balance of one or more promissory notes
described in the attached TREC Loan Assumption Addendum.
 C. SELLER FINANCING: A promissory note from Buyer to Seller of $
, secured by
vendor's and deed of trust liens, and containing the terms and conditions described in the attached
TREC Seller Financing Addendum. If an owner policy of title insurance is furnished, Buyer shall
furnish Seller with a mortgagee policy of title insurance.
Initialed for identification by Buyer
and Seller
TREC NO. 20-12
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6
Texas Law of Contracts Second Edition Update
Remember that you must use promulgated forms unless one of the four exceptions
(see “537.11. Use of Standard Contract Forms” later in this unit) comes into play.
Texas Real Estate Commission Forms
■■ Promulgated contracts
■■
■■
■■
■■
■■
■■
—— Unimproved Property Contract
—— One to Four Family Residential Contract (Resale)
—— New Home Contract (Incomplete Construction)
—— New Home Contract (Completed Construction)
—— Farm and Ranch Contract
—— Residential Condominium Contract (Resale)
Promulgated addenda
—— Addendum for Sale of Other Property by Buyer
—— Addendum for Back-up Contract
—— Addendum for Release of Liability on Assumed Loan and/or Restoration
of Seller’s VA Entitlement
—— Seller’s Temporary Residential Lease
—— Buyer’s Temporary Residential Lease
—— Seller Financing Addendum
—— Environmental Assessment, Threatened or Endangered Species, and
Wetlands Addendum
—— Addendum for Coastal Area Property
—— Addendum for Property Located Seaward of the Gulf Intracoastal
Waterway
—— Addendum for Property Subject to Mandatory Membership in an Owners’ Association
—— Third Party Financing Addendum for Credit Approval
—— Loan Assumption Addendum
—— Addendum for Reservation of Oil, Gas and Other Minerals
—— Short Sale Addendum
—— Addendum for Property in a Propose Gas System Service Area
Promulgated amendment
—— Amendment to Contract
Promulgated resale certificates
—— Condominium Resale Certificate
—— Subdivision Information, Including Resale Certificate for Property Subject to Membership in a Property Owners’ Association
Promulgated notice
—— Notice of Buyer’s Termination of Contract
Promulgated consumer disclosures
—— Disclosure of Relationship with Residential Service Company
Approved optional/voluntary use forms
—— Notice to Prospective Buyer
—— Seller’s Disclosure of Property Condition
—— Texas Real Estate Consumer Notice Concerning Hazards or Deficiencies
—— Information About Brokerage Services
—— Lead-Based Paint Addendum
—— Non-Realty Items Addendum
—— Reverse Mortgage Financing Addendum
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Unit 1 Texas Contract Law
7
In addition to itemizing the current inventory of available forms, the commission
establishes the dos and don’ts for the completion of those forms. A careful reading
of the rules tells licensees all they need to know:
537.11. Use of Standard Contract Forms
(a) When negotiating contracts binding the sale, exchange, option,
lease or rental of any interest in real property, a real estate licensee shall
use only those contract forms promulgated by the Texas Real Estate Commission (the commission) for that kind of transaction with the following
exceptions:
(1) transactions in which the licensee is functioning solely as a principal, not as an agent;
(2) transactions in which an agency of the United States government requires a different form to be used;
(3) transactions for which a contract form has been prepared by a
principal to the transaction or prepared by an attorney and required by a
principal to the transaction; or
(4) transactions for which no standard contract form has been
promulgated by the commission, and the licensee uses a form prepared by
an attorney at law licensed by this state and approved by the attorney for
the particular kind of transactions involved or prepared by the Texas Real
Estate Broker-Lawyer Committee (the committee) and made available for
trial use by licensees with the consent of the commission.
(b) A licensee may not:
(1) practice law,
(2) offer, give or attempt to give legal advice, directly or indirectly;
(3) give advice or opinions as to the legal effect of any contracts or
other such instruments which may affect the title to real estate;
(4) give opinions concerning the status or validity of title to real
estate; or
(5) attempt to prevent or in any manner whatsoever discourage any
principal to a real estate transaction from employing a lawyer.
(c) Nothing in this section shall be deemed to limit the licensee’s fiduciary obligation to disclose to the licensee’s principals all pertinent facts
which are within the knowledge of the licensee, including such facts which
might affect the status of or title to real estate.
(d) A licensee may not undertake to draw or prepare documents fixing
and defining the legal rights of the principals to a real estate transaction.
(e) In negotiating real estate transactions, the licensee may fill in forms
for such transactions, using exclusively forms which have been approved
and promulgated by the commission or such forms as are otherwise permitted by these rules.
(f) When filling in a form authorized for use by this section, the licensee
may only fill in the blanks provided and may not add to or strike matter
from such form, except that licensees shall add factual statements and business details desired by the principals and shall strike only such matter as is
desired by the principals and as is necessary to conform the instrument to
the intent of the parties.
(g) A licensee may not add to a promulgated contract form factual
statements or business details for which a contract addendum, lease or other
form has been promulgated by the commission for mandatory use.
(h) Nothing in this section shall be deemed to prevent the licensee
from explaining to the principals the meaning of the factual statements and
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8
Texas Law of Contracts Second Edition Update
business details contained in the said instrument so long as the licensee does
not offer or give legal advice.
(i) It is not the practice of law as defined in this Act for a real estate
licensee to complete a contract form which is either promulgated by the commission or prepared by the committee and made available for trial use by
licensees with the consent of the commission.
(j) Contract forms prepared by the committee for trial use may be used
on a voluntary basis after being approved by the commission.
(k) Contract forms prepared by the committee and approved by the
commission to replace previously promulgated forms may be used by licensees on a voluntary basis prior to the effective date of rules requiring use of
the replacement forms.
(l) Where it appears that, prior to the execution of any such instrument, there are unusual matters involved in the transaction which should be
resolved by legal counsel before the instrument is executed or that the instrument is to be acknowledged and filed for record, the licensee shall advise the
principals that each should consult a lawyer of the principal’s choice before
executing same.
(m) A licensee may not employ, directly or indirectly, a lawyer nor pay
for the services of a lawyer to represent any principal to a real estate transaction in which the licensee is acting as an agent. The licensee may employ
and pay for the services of a lawyer to represent only the licensee in a real
estate transaction, including preparation of the contract, agreement, or
other legal instruments to be executed by the principals to the transactions.
(n) A licensee shall advise the principals that the instrument they are
about to execute is binding on them.
(o) Forms approved or promulgated by the commission may be reproduced only from the following sources:
(1) numbered copies obtained from the commission, whether in a
printed format or electronically reproduced from the files available on the
commission’s web site;
(2) printed copies made from copies obtained from the commission;
(3) legible photocopies made from such copies; or
(4) computer-driven printers following these guidelines:
(A) The computer file or program containing the form text must
not allow the end user direct access to the text of the form and may only
permit the user to insert language in blanks in the forms or to strike through
language at the direction of the parties to the contract.
(B) Typefaces or fonts must appear to be identical to those used
by the commission in printed copies of the particular form.
(C) The text and number of pages must be identical to that used
by the commission in printed copies of the particular form.
(D) The spacing, length of blanks, borders and placement of text
on the page must appear to be identical to that used by the commission in
printed copies of the form.
(E) The name and address of the person or firm responsible for
developing the software program must be legibly printed below the border at
the bottom of each page in no less than six point type and in no larger than
10 point type.
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9
Unit 1 Texas Contract Law
(p) Forms approved or promulgated by the commission must be reproduced on the same size of paper used by the commission with the following
changes or additions only:
(1) The business name or logo of a broker, organization or printer
may appear at the top of a form outside the border.
(2) The broker’s name may be inserted in any blank provided for
that purpose.
Owner Disclosure Requirements
Section 5.008 of the Texas Property Code requires “a seller of residential property comprising not more than one dwelling unit located in this state to give to
the purchaser of the property” a written notice of the property’s condition. Form
OP-H, Seller’s Disclosure of Property Condition (see Figure 1.2), contains the
language required by the Property Code.
Notice that TREC seller’s disclosure is an optional form, not a promulgated form.
The disclosure is required of the seller, but the Property Code does not dictate
which form the seller needs to use. All the information on this form is required by
the Property Code and is also on the Texas Association of REALTORS® (TAR)
Seller’s Disclosure of Property Condition form as well as some of the REALTOR®
associations’ and some brokers’ forms. TAR forms also include additional disclosure items.
Sellers can limit their future liability by disclosing everything they know about
the property. Even things that have been repaired or replaced need to be disclosed
on the notice.
The seller’s disclosure is discussed in paragraph 7B of the TREC-promulgated contract forms; we will use the One to Four Family Residential Contract as an example. Paragraph 7B (see Figure 1.3) gives the parties three choices for negotiations.
Paragraph 7B(1) is the easiest disclosure option and probably the best choice. In
order for this to be available, the listing agent must have the form completed in
advance. Many agents take a blank seller disclosure form in their listing packet
and get the seller to complete it as soon as they list the property. Then they are
ready to provide it when a buyer becomes interested.
Buyers need to review the seller’s disclosure notice before making an offer. That
way, buyers know what they are making an offer on “in its present condition” and
can negotiate appropriately.
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FIGURE 1.2: Seller’s Disclosure of Property Condition
10-23-2013
APPROVED BY THE TEXAS REAL ESTATE COMMISSION (TREC)
SELLER'S DISCLOSURE OF PROPERTY CONDITION
CONCERNING THE PROPERTY AT
(Street Address and City)
THIS NOTICE IS A DISCLOSURE OF SELLER'S KNOWLEDGE OF THE CONDITION OF THE PROPERTY AS OF THE DATE SIGNED BY
SELLER AND IS NOT A SUBSTITUTE FOR ANY INSPECTIONS OR WARRANTIES THE PURCHASER MAY WISH TO OBTAIN. IT IS NOT
A WARRANTY OF ANY KIND BY SELLER OR SELLER'S AGENTS.
Seller
is
is not occupying the Property. If unoccupied, how long since Seller has occupied the Property?
1. The Property has the items checked below [Write Yes (Y), No (N), or Unknown (U)]:
Range
Oven
Microwave
Dishwasher
Trash Compactor
Disposal
Washer/Dryer Hookups
Window Screens
Rain Gutters
Security System
Fire Detection Equipment
Intercom System
Smoke Detector
Smoke Detector-Hearing Impaired
Carbon Monoxide Alarm
Emergency Escape Ladder(s)
TV Antenna
Cable TV Wiring
Satellite Dish
Ceiling Fan(s)
Attic Fan(s)
Exhaust Fan(s)
Central A/C
Central Heating
Wall/Window Air Conditioning
Plumbing System
Patio/Decking
Septic System
Public Sewer System
Outdoor Grill
Fences
Pool
Sauna
Pool Equipment
Fireplace(s) & Chimney
(Wood burning)
Pool Heater
Spa
Hot Tub
Automatic Lawn Sprinkler System
Fireplace(s) & Chimney
(Mock)
Natural Gas Lines
Gas Fixtures
Liquid Propane Gas
LP Community (Captive)
LP on Property
Not Attached
Carport
Garage Door Opener(s):
Electronic
Control(s)
Water Heater:
Gas
Electric
Garage:
Attached
Water Supply:
Roof Type:
City
Well
MUD
Co-op
Age:
(approx.)
Are you (Seller) aware of any of the above items that are not in working condition, that have known defects, or that are in
No
Unknown. If yes, then describe. (Attach additional sheets if necessary):
need of repair? Yes
TREC No. OP-H
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Unit 1 Texas Contract Law
FIGURE 1.2: Seller’s Disclosure of Property Condition (continued)
Page 2
Seller's Disclosure Notice Concerning the Property at
10-23-2013
(Street Address and City)
2.
Does the property have working smoke detectors installed in accordance with the smoke detector requirements of Chapter
Yes
No
Unknown. If the answer to this question is no or unknown, explain
766, Health and Safety Code?
(Attach additional sheets if necessary):
*
Chapter 766 of the Health and Safety Code requires one-family or two-family dwellings to have working smoke detectors
installed in accordance with the requirements of the building code in effect in the area in which the dwelling is located,
including performance, location, and power source requirements. If you do not know the building code requirements in
effect in your area, you may check unknown above or contact your local building official for more information. A buyer may
require a seller to install smoke detectors for the hearing impaired if: (1) the buyer or a member of the buyer's family who
will reside in the dwelling is hearing impaired; (2) the buyer gives the seller written evidence of the hearing impairment from
a licensed physician; and (3) within 10 days after the effective date, the buyer makes a written request for the seller to install
smoke detectors for the hearing impaired and specifies the locations for the installation. The parties may agree who will bear
the cost of installing the smoke detectors and which brand of smoke detectors to install.
3.
Are you (Seller) aware of any known defects/malfunctions in any of the following? Write Yes (Y) if you are aware, write No (N)
if you are not aware.
Interior Walls
Ceilings
Floors
Exterior Walls
Doors
Windows
Roof
Foundation/Slab(s)
Sidewalks
Walls/Fences
Driveways
Intercom System
Plumbing/Sewers/Septics
Electrical Systems
Lighting Fixtures
Other Structural Components (Describe):
If the answer to any of the above is yes, explain. (Attach additional sheets if necessary):
4.
Are you (Seller) aware of any of the following conditions? Write Yes (Y) if you are aware, write No (N) if you are not aware.
Active Termites (includes wood destroying insects)
Previous Structural or Roof Repair
Termite or Wood Rot Damage Needing Repair
Hazardous or Toxic Waste
Previous Termite Damage
Asbestos Components
Previous Termite Treatment
Urea-formaldehyde Insulation
Previous Flooding
Radon Gas
Improper Drainage
Lead Based Paint
Water Penetration
Aluminum Wiring
Located in 100-Year Floodplain
Previous Fires
Present Flood Insurance Coverage
Unplatted Easements
Landfill, Settling, Soil Movement, Fault Lines
Subsurface Structure or Pits
Previous Use of Premises for Manufacture of
Methamphetamine
Single Blockable Main Drain in Pool/Hot Tub/Spa
If the answer to any of the above is yes, explain. (Attach additional sheets if necessary):
* A single blockable main drain may cause a section entrapment hazard for an individual.
TREC No. OP-H
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Texas Law of Contracts Second Edition Update
FIGURE 1.2: Seller’s Disclosure of Property Condition (continued)
Page 3
Seller's Disclosure Notice Concerning the Property at
(Street Address and City)
5.
Are you (Seller) aware of any item, equipment, or system in or on the Property that is in need of repair?
No (if you are not aware) If yes, explain. (Attach additional sheets if necessary):
6.
Are you (Seller) aware of any of the following? Write Yes (Y) if you are aware, write No (N) if you are not aware.
10-23-2013
Yes (if you are aware)
Room additions, structural modifications, or other alterations or repairs made without necessary permits or not in
compliance with building codes in effect at that time.
Homeowners' Association or maintenance fees or assessments.
Any "common area" (facilities such as pools, tennis courts, walkways, or other areas) co-owned in undivided interest
with others.
Any notices of violations of deed restrictions or governmental ordinances affecting the condition or use of the
Property.
Any lawsuits directly or indirectly affecting the Property.
Any condition on the Property which materially affects the physical health or safety of an individual.
Any rainwater harvesting system located on the property that is larger than 500 gallons and that uses a public water
supply as an auxiliary water source.
If the answer to any of the above is yes, explain. (Attach additional sheets if necessary):
7.
If the property is located in a costal area that is seaward of the Gulf Intracoastal Waterway or within 1,000 feet of the mean
high tide bordering the Gulf of Mexico, the property may be subject to the Open Beaches Act or the Dune Protection Act
(Chapter 61 or 63, Natural Resources Code, respectively) and a beachfront construction certificate or dune protection permit
maybe required for repairs or improvements. Contact the local government with ordinance authority over construction
adjacent to public beaches for more information.
Signature of Seller
Date
Signature of Seller
Date
The undersigned purchaser hereby acknowledges receipt of the foregoing notice.
Signature of Purchaser
Date
Signature of Purchaser
Date
TREC No. OP-H
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(8) TRANSFER FEES: If the Property is subject to a private transfer fee obligation, §5.205,
Property Code, requires Seller to notify Buyer as follows: The private transfer fee
obligation may be governed by Chapter 5, Subchapter G of the Texas Property Code.
(9) PROPANE GAS SYSTEM SERVICE AREA: If the Property is located in a propane gas
system service area owned by a distribution system retailer, Seller must give Buyer
written notice as required by §141.010, Texas Utilities Code. An addendum containing
the notice approved by TREC or required by the parties should be used.
Unit 1 Texas Contract Law
13
7. PROPERTY CONDITION:
A. ACCESS, INSPECTIONS AND UTILITIES: Seller shall permit Buyer and Buyer’s agents access
to the Property at reasonable times. Buyer may have the Property inspected by inspectors
selected by Buyer and licensed by TREC or otherwise permitted by law to make inspections.
FIGURE 1.3: Paragraph
7B of expense
the Oneshall
to Four
Family Residential
Seller at Seller's
immediately
cause existingContract
utilities to be turned on and shall
keep the utilities on during the time this contract is in effect.
B. SELLER'S DISCLOSURE NOTICE PURSUANT TO §5.008, TEXAS PROPERTY CODE (Notice):
(Check one box only)
 (1) Buyer has received the Notice.
 (2) Buyer has not received the Notice. Within
days after the effective date of this
contract, Seller shall deliver the Notice to Buyer. If Buyer does not receive the Notice,
Buyer may terminate this contract at any time prior to the closing and the earnest money
will be refunded to Buyer. If Seller delivers the Notice, Buyer may terminate this contract
for any reason within 7 days after Buyer receives the Notice or prior to the closing,
whichever first occurs, and the earnest money will be refunded to Buyer.
 (3)The Seller is not required to furnish the notice under the Texas Property Code.
C. SELLER’S DISCLOSURE OF LEAD-BASED PAINT AND LEAD-BASED PAINT HAZARDS is
required by Federal law for a residential dwelling constructed prior to 1978.
Paragraph
7B(2)
is for the buyer’s
agent
whothe
is preparing
an offer of
butthe
hasProperty
not been
D. ACCEPTANCE OF
PROPERTY
CONDITION:
“As Is”
means
present condition
with any and able
all defects
without seller’s
warranty
except from
for the
of The
title buyer
and the
to get aand
completed
disclosure
the warranties
listing agent.
can
warranties in this contract. Buyer’s agreement to accept the Property As Is under Paragraph
make
an
offer
and
ask
the
seller
to
provide
the
notice
within
a
certain
number
7D(1) or (2) does not preclude Buyer from inspecting the Property under Paragraph 7A, fromof
negotiating repairs
or treatments
a subsequent
orthe
from
terminating
days. The
risk for the in
sellers
is that evenamendment,
if they deliver
disclosure
withinthis
the
contract during the Option Period, if any.
proper
(Check one box
only)time frame, the buyer can terminate the contract, for any reason, within
seven
days
and receive
 (1) Buyer accepts
the
Property
As Is. the earnest money back. If the sellers never deliver it, the
 (2) Buyer accepts
As terminate
Is provided
Seller,
at the
Seller’s
expense,
buyerthe
hasProperty
a right to
and
receive
earnest
moneyshall
backcomplete
up to thethe
day
following specific repairs and treatments:
of closing.
.
(Do not insert general phrases, such as “subject to inspections” that do not identify
Paragraph
7B(3) is for the seller, who (by law) is not required to furnish the notice.
specific repairs
and treatments.)
E. LENDER REQUIRED
REPAIRS
ANDbelief,
TREATMENTS:
Unless
otherwise
agreed are
in writing,
Contrary
to popular
investors and
relocation
companies
required neither
to proparty is obligated to pay for lender required repairs, which includes treatment for wood
vide
the
notice.
As
per
Section
5.008(e)
of
the
Texas
Property
Code,
the
notice
is
destroying insects. If the parties do not agree to pay for the lender required repairs or
treatments, this
contract
will
terminate
and
the
earnest
money
will
be
refunded
to
Buyer.
If
not required for transactions
the cost of lender required repairs and treatments exceeds 5% of the Sales Price, Buyer may
(1)earnest
pursuant
to a court
order
or foreclosure
sale;
terminate this contract and the
money
will be
refunded
to Buyer.
F. COMPLETION OF REPAIRS AND
Unless otherwise agreed in writing: (i) Seller
(2)TREATMENTS:
by a trustee in bankruptcy;
shall complete all agreed repairs and treatments prior to the Closing Date; and (ii) all required
(3)repairs
to a mortgagee
by a mortgagor
orperformed
successor inbyinterest,
or who
to a are
permits must be obtained, and
and treatments
must be
persons
licensed to provide such
repairs
or
treatments
or,
if
no
license
is
required
by
law,
are
beneficiary of a deed of trust by a trustor or successor in interest;
commercially engaged in the trade of providing such repairs or treatments. At Buyer’s
(4) by a mortgagee
a beneficiary
under
a deedtoof the
trust repairs
who has and
election, any transferable warranties
receivedorby
Seller with
respect
acquired the
property
at a saleexpense.
conductedIf pursuant
to a to
power
of sale any
treatments will be transferred
to real
Buyer
at Buyer’s
Seller fails
complete
agreed repairs and treatments
prior
to the
Closing
Date, to
Buyer
may
exercise
remedies
under
under
a
deed
of
trust
or
a
sale
pursuant
a
court
ordered
foreclosure
or has
Paragraph 15 or extend the Closing Date up to 5 days if necessary for Seller to complete the
acquired the real property by a deed in lieu of foreclosure;
repairs and treatments.
G. ENVIRONMENTAL MATTERS:
Buyer
advised in
that
presence
of wetlands, of
toxic
substances,
(5)
by aisfiduciary
the the
course
of the administration
a decedent’s
including asbestos and wastes or other environmental hazards, or the presence of a
estate, species
guardianship,
conservatorship,
trust;Buyer’s intended use of the
threatened or endangered
or its
habitat may or
affect
(6) from one co-owner to one or more other co-owners;
and Seller
TREC NO. 20-12
(7) made to a spouse or to a person or persons in the lineal line of
consanguinity of one or more of the transferors;
(8) between spouses resulting from a decree of dissolution of marriage or a decree of legal separation or from a property settlement agreement
incidental to such a decree;
(9) to or from any governmental entity;
(10) of a new residence of not more than one dwelling unit which
has not previously been occupied for residential purposes; or
(11) of real property where the value of any dwelling does not exceed
five percent of the value of the property.
Initialed for identification by Buyer
Section 5.008 also states the following:
(c) A seller or seller’s agent shall have no duty to make a disclosure or
release information related to whether a death by natural causes, suicide,
or accident unrelated to the condition of the property occurred on the property or whether a previous occupant had, may have had, has, or may have
AIDS, HIV related illnesses, or HIV infection.
(d) The notice shall be completed to the best of seller’s belief and knowledge as of the date the notice is completed and signed by the seller. If the
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Texas Law of Contracts Second Edition Update
information required by the notice is unknown to the seller, the seller shall
indicate that fact on the notice, and by that act is in compliance with this
section.
(f) The notice shall be delivered by the seller to the purchaser on or
before the effective date of an executory contract binding the purchaser to
purchase the property. If a contract is entered without the seller providing
the notice required by this section, the purchaser may terminate the contract
for any reason within seven days after receiving the notice.
Section 5.008(g) of the Property Code also provides definitions for two terms in
the seller disclosure notice:
(1) “Blockable main drain” means a main drain of any size and
shape that a human body can sufficiently block to create a suction entrapment hazard.
(2) “Main drain” means a submerged suction outlet typically located
at the bottom of a swimming pool or spa to conduct water to a recirculating
pump.
As stated previously, failure to provide the disclosure can produce negative results
for the seller. When the seller fails to provide and the buyer of a previously occupied single-family residence fails to receive the seller disclosure as required by Section 5.008 of the Texas Property Code, the contract may be terminated at the sole
option of the buyer and is therefore voidable at the option of the buyer.
DECEPTIVE TRADE PRACTICES ACT
Real estate agents must use extreme care to deliver information that is accurate,
complete, and completely accurate. The Deceptive Trade Practices Act (DTPA)
is a consumer protection act which protects the public from
■■ any false, misleading or deceptive act; and
■■ a licensee taking advantage of the consumer’s lack of knowledge, ability,
experience, or capacity to a grossly unfair degree (i.e., an unconscionable
act).
The primary difference between an action brought under DTPA and any other
civil suit is that treble damages and mental anguish are available in the DTPA
action. Additionally, court costs and attorneys’ fees may be added. The main distinction between treble damages, or simply actual damages, is the word knowingly.
If the real estate agent used a misleading statement without the knowledge of its
falsity, then the treble damages may not be awarded.
The most likely trap for the real estate practitioner is the omission or commission
of a material fact. Of the two most popular problems, the act of omission is the
most prevalent, either by knowing or not knowing.
The treble damages portion can be defeated by offering to settle for an amount
which is greater than that awarded in the suit.
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Unit 1 Texas Contract Law
15
SUMMARY
Real estate in Texas is governed by state law. The Texas Real Estate License Act
(TRELA) and the TREC Rules are enforced by the Texas Real Estate Commission
(TREC).
The Broker-Lawyer Committee drafts and edits contract forms for use by real
estate licensees, and TREC approves and promulgates them.
Real estate licensees must use the promulgated forms except in specific exempted
cases. Failure to use these forms where required might lead to the suspension or
revocation of one’s license for the unauthorized practice of law.
Promulgated contract forms cannot be altered except as a requirement of the
parties.
The Texas Property Code requires most sellers of residential property (with some
exceptions) to provide to the purchaser a written notice of the property’s condition. TREC has provided a form for this purpose.
The Deceptive Trade Practices Act (DTPA) protects consumers from licensees
who knowingly make false or deceptive statements.
UNIT 1 REVIEW QUESTIONS
1. The purpose of the Texas Real Estate License Act (TRELA) is to
a. protect real estate licensees.
b. protect real estate brokers from unscrupulous salespeople.
c. protect the public.
d. keep the cost of real estate services under control.
2. The Texas Deceptive Trade Practices Act (DTPA) is a consumer protection law which protects the public
from
a. false or misleading acts.
b. deceptive acts.
c. unconscionable acts.
d. all of these.
3. Which action might leave a licensee open to a charge of practicing law without a license?
a. Licensee advises the seller that the property probably won’t sell because it is overpriced.
b. Licensee advises the buyer in writing that a title policy, as well as a survey, should be obtained.
c. Licensee advises both the seller and the buyer that, in his opinion, title to the subject property is
encumbered.
d. Licensee adds factual statements and business details to a promulgated form as requested by the client.
4. In which of the following situations is a licensee NOT required to use a contract promulgated by the Texas
Real Estate Commission (TREC)?
a. The licensee’s broker provides an alternative contract.
b. The licensee is working as his father’s agent to sell his father’s house.
c. The buyer’s attorney has drafted a contract that the buyer insists on using.
d. The buyer doesn’t like the TREC contract and asks the licensee to draft a different sales contract.
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Texas Law of Contracts Second Edition Update
5. What should a licensee do in transactions for which there is no TREC promulgated contract?
a. Change an existing TREC-promulgated contract to meet the needs of this transaction.
b. Write a contract according to the wishes of the principal.
c. Ask the buyer and the seller to work together to draft a contract.
d. Use a form prepared by the Broker-Lawyer Committee and made available for trial use by licensees
with the consent of TREC.
6. The Texas Deceptive Trade Practices Act (DTPA) has two features that are designed to deter wrongdoers.
These two features are
a. treble damages and a mental anguish award.
b. actual damages and a minimum punitive award of $1 million.
c. 10 times actual damages and attorneys’ fees.
d. treble damages and actual damages.
7. The Texas Property Code Section 5.008 requires all of the following to provide a seller’s disclosure
EXCEPT
a. one spouse to another in a divorce proceeding.
b. an out-of-state investor who has never seen the property.
c. a sale in which the improvements are worth less than half of the land assessment.
d. a local investor who has never lived in the property.
8. Section 5.008 of the Texas Property Code requires
a. most sellers of residential property to provide the buyer with a written notice of the property’s
condition.
b. all sellers of residential property to provide the buyer with a written notice of the property’s condition.
c. most sellers of residential property to provide the buyer with TREC Form OP-H, Seller’s Disclosure of
Property Condition.
d. all sellers of residential property to provide the buyer with TREC Form OP-H, Seller’s Disclosure of
Property Condition.
9. Which of the following is NOT a promulgated form adopted by the Texas Real Estate Commission
(TREC)?
a. A contract for the sale of a farm
b. A contract for the resale of a condominium
c. A contract for the sale of a five-unit residential building
d. A contract for the sale of a duplex
10. If the disclosure is provided to the buyer after the contract is fully executed, the
a. buyer may terminate the contract within ten days after receipt of the disclosure.
b. buyer may terminate the contract within seven days after receipt of the disclosure.
c. buyer has no right to terminate the contract.
d. seller is required to pay all of the buyer’s closing costs.
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2
U N I T
■■
LEARNING OBJECTIVES
Basics of Real Estate Law
When you have completed this unit, you will be able to
■■ define land, real estate, and real property;
■■ describe the rights individuals can have in the ownership and use of real
■■
■■
■■
■■
■■
■■
■■
estate;
give examples of real and personal property;
describe and identify fixtures and trade fixtures;
review the characteristics of real property;
compare the ways that title can be held in co-ownership: tenancy in common, joint tenancy, tenancy by the entirety, and community property;
explain the different ways property can be owned by married couples;
describe the ways in which various business organizations may own property; and
compare the condominium, cooperative, town-house, and time-share forms
of property ownership.
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Texas Law of Contracts Second Edition Update
KEY TERMS
air rights
annexation
appurtenance
area preference
assessment
beneficiary
bundle of legal rights
common elements
community property
condominium
co-ownership
cooperative
corporation
fixture
general partnership
improvement
joint tenancy
land
limited liability company
(LLC)
limited partnership
manufactured housing
nonhomogeneity
partition
partnership
personal property
proprietary lease
real estate
real property
right of survivorship
separate property
severalty
severance
situs
subsurface rights
surface rights
tenancy in common
time-share
time-share estate
time-share use
title
trade fixture
trust
trustee
trustor
water rights
REAL PROPERTY AND THE LAW
Real estate is a market like any other. Real property is a product, and the broker
or the licensee is the salesperson. The sales agreement is a contract with all its
many elements. Before beginning the study of the law of contracts, it is important
to establish a foundation of understanding of basic real estate law. Real estate
licensees are generally not attorneys and must always be cautious to not appear
to be providing legal advice. However, providing a client with basic information
regarding various aspects of real estate law is not only appropriate but is also an
important part of fulfilling the fiduciary duty to protect the best interests of the
client. This unit reviews many of the precepts of real estate law that are covered
in the first prelicensing course that real estate professionals are required to take.
Hopefully, this unit will serve as a review and as preparation for delving further
into basic contract law.
LAND, REAL ESTATE, AND REAL PROPERTY
The terms land, real estate, and real property are often used interchangeably. To
most people, they mean the same thing. Strictly speaking, however, the terms
refer to different aspects of ownership interests in land. To fully understand the
nature of real estate and the laws that affect it, real estate licensees must be aware
of the subtle yet important differences in meaning of these words.
Land
Land is defined as the earth’s surface extending downward to the center of the
earth and upward to infinity, including permanent natural objects, such as trees
and water (see Figure 2.1).
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19
Unit 2 Basics of Real Estate Law
FIGURE 2.1: Land, Real Estate, and Real Property
Air Rights
Physical
Improvements
Surface
Rights
Subsurface
Rights
The Bundle
of Rights
Land
Earth’s surface to the center of
the earth and the airspace above the
land, including the trees and water
Real Estate
Land plus permanent
human-made additions
Real Property
Real estate plus
“bundle of legal rights”
Land includes not only the surface of the earth but also the underlying soil. It
refers to things that are naturally attached to the land, such as boulders and plants.
It includes the minerals and substances that lie far below the earth’s surface. Land
even includes the air above the earth, all the way into space. These are known
respectively as the subsurface and the airspace. Most of the earth’s surface, of
course, is not land at all, but water. Special state and local laws govern the ownership of the wetter parts of the earth, including lakes and rivers.
Real Estate
Real estate is defined as land at, above, and below the earth’s surface, plus all
things permanently attached to it, whether natural or artificial (see Figure 2.1).
The term real estate, or realty, is similar to the term land but includes not only the
natural components of the land but also all permanent man-made improvements
on and to the land. An improvement is any artificial thing attached to the land,
such as a building or a fence, as well as infrastructures, such as sewers.
Real Property
The term real property is the broadest of all. It includes both land and real estate.
Real property is defined as the interests, benefits, and rights that are automatically
included in the ownership of land and real estate (see Figure 2.1).
Real property includes the earth’s surface, subsurface, and airspace, including all
things permanently attached to it by nature or people, and the legal rights innate
to the ownership of a parcel of real estate.
Traditionally, ownership rights of real property are described as a bundle of legal
rights. These rights include the
■■ right of possession,
■■ right to control the property (within the framework of the law),
■■ right of enjoyment (to use the property in any legal manner),
■■ right of exclusion (to keep others from entering or using the property), and
■■ right of disposition (to sell, will, transfer, or otherwise dispose of or encumberorthe
property).
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The concept of a bundle of rights comes from old English law. In the Middle
Ages, a seller transferred property by giving the purchaser a handful of earth or a
bundle of bound sticks from a tree on the property. After accepting the bundle, the
purchaser became the owner of the tree from which the sticks came and the land
to which the tree was attached. Because the rights of ownership (like the sticks)
can be separated and individually transferred, the sticks became symbolic of those
rights (see Figure 2.2).
FIGURE 2.2: The Bundle of Legal Rights
Possession
Control
Enjoyment
Exclusion
Disposition
The word title, as it relates to real property, has two meanings: (1) the right to or
ownership of the land, including the owner’s bundle of legal rights; and (2) evidence of that ownership by a deed. Title refers to ownership of real property, not
to a printed document. The document by which the owner transfers title to the
real property is the deed.
Real property is often coupled with the word appurtenance. An appurtenance (runs
with the land) is a right or privilege associated with the property, although not
necessarily a part of it. Typical appurtenances include parking spaces in multiunit
buildings, easements, water rights, and other improvements. An appurtenance is
connected to the property, and ownership of the appurtenance normally transfers
to the new owner when the property is sold.
I N P R A C T I C E When people talk about buying or selling homes, office buildings, and land, they usually call these things real estate. For all practical purposes,
the term real estate is synonymous with real property as defined here. In everyday
usage, real estate includes the legal rights of ownership specified in the definition of
real property. Sometimes people use the term realty instead.
Subsurface, Air, and Water Rights Surface rights refer to the use of the surface of the earth. Subsurface rights are the rights to the natural resources below
the earth’s surface. An owner may transfer surface rights without transferring subsurface rights.
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Unit 2 Basics of Real Estate Law
21
E X A M P L E A landowner sells the rights to any oil and gas found beneath
the owned farm to an oil company. Later, the same landowner sells the remaining interests (the surface, air, and limited subsurface rights) to a buyer, reserving the rights to
any coal that may be found and to pasture on the land. This buyer sells the remaining
land to yet another buyer but retains the farmhouse, stable, and pasture. After these
sales, four parties have ownership interests in the same real estate: (1) the original
landowner owns all the coal; (2) the oil company owns all the oil and gas; (3) the first
buyer owns the farmhouse, stable, and pasture; and (4) the second buyer owns the
rights to the remaining real estate (see Figure 2.3).
F O R
FIGURE 2.3: Surface and Subsurface Rights
Farmhouse
Stable
Oil and Gas
Coal
Air rights, the rights to use the space above the earth, may be sold or leased independently, provided the rights have not been preempted by law. Air rights can be
an important part of real estate, particularly in large cities, where air rights over
railroads must be purchased or leased to construct office buildings, hotels, or other
multistory structures. To construct such a building, the developer must purchase
not only the air rights but also numerous small portions of the land’s surface for
the building’s foundation supports.
Before air travel was common, a property’s air rights were considered unlimited,
extending upward into the farthest reaches of outer space. Today, the courts permit reasonable interference with these rights, such as what is necessary for aircraft
(and presumably spacecraft), as long as the owner’s right to use and occupy the
land is not unduly lessened. Government and airport authorities often purchase
adjacent air rights to provide approach patterns for air traffic.
With the continuing development of solar power, air rights—and, more specifically, light or solar rights—are being closely examined by the courts. A new tall
building that blocks sunlight from a smaller existing building may be held to be
interfering with the smaller building’s right to sunlight, particularly if systems in
the smaller building are solar powered. Air and solar rights are regulated by state
and local laws and ordinances.
Water rights are special common-law rights held by owners of land adjacent to
rivers, lakes, or oceans and are restrictions on the rights of land ownership. Water
rights are particularly important in drier western states, where water is a scarce and
valuable public commodity (see Unit 4).
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Texas Law of Contracts Second Edition Update
REAL PROPERTY VS. PERSONAL PROPERTY
Property may be classified as either real or personal. Personal property is all the
property that can be owned and that does not fit the definition of real property. An
important distinction between the two is that personal property is movable. Items
of personal property, also called chattels, include such tangibles as chairs, tables,
clothing, money, bonds, and bank accounts.
Manufactured Housing
Manufactured housing is defined as dwellings that are built off-site and transported to a building lot where they are installed or assembled. Manufactured housing includes both modular and completed units generally referred to in the past
as mobile homes. Use of the term mobile homes was phased out with the passage
of the National Manufactured Housing Construction and Safety Standards Act of
1976, when manufactured homes became federally regulated. Nevertheless, the
term mobile home is still commonly used by the public.
The distinction between real and personal property of a manufactured home is not
always obvious. Manufactured housing may be considered personal property, even
though its mobility may be limited to a single trip to a park or development to be
hooked up to utilities. Manufactured housing may also be considered real property
if it becomes permanently affixed to the land. The classification of real or personal
property becomes significant when financing is involved. State law may vary with
regard to registration of title to the property.
Section 1201.2055 of the Texas Occupations Code addresses the status of manufactured housing as real or personal property:
(a) In completing an application for the issuance of a statement of
ownership and location, an owner of a manufactured home shall indicate
whether the owner elects to treat the home as personal property or real property. An owner may elect to treat a manufactured home as real property
only if the home is attached to:
(1) real property that is owned by the owner of the home; or
(2) land leased to the owner of the home under a long-term lease,
as defined by department rule.
(b) Repealed by Acts 2009, 81st Leg., R.S., Ch. 77, Sec. 15(2), eff.
September 1, 2009.
(c) If the department issues a statement of ownership and location to an
owner who has elected to treat a manufactured home as personal property,
the statement of ownership and location on file with the department is evidence of ownership of the home. A lien, charge, or other encumbrance on a
home treated as personal property may be made only by filing the appropriate document with the department.
(d) If an owner elects to treat a manufactured home as real property,
the department shall issue to the owner a certified copy of the statement of
ownership and location that on its face reflects that the owner has elected
to treat the manufactured home as real property at the location listed on the
statement. Not later than the 60th day after the date the department issues
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Unit 2 Basics of Real Estate Law
a certified copy of the statement of ownership and location to the owner, the
owner must:
(1) file the certified copy in the real property records of the county
in which the home is located; and
(2) notify the department and the chief appraiser of the applicable
appraisal district that the certified copy has been filed.
(e) A real property election for a manufactured home is not considered
to be perfected until a certified copy of the statement of ownership and
location has been filed and the department and the chief appraiser of the
applicable appraisal district have been notified of the filing as provided by
Subsection (d).
(f) Repealed by Acts 2011, 82nd Leg., R.S., Ch. 46, Sec. 8(1), eff.
September 1, 2011.
(g) After a real property election is perfected under Subsection (e):
(1) the home is considered to be real property for all purposes; and
(2) no additional issuance of a statement of ownership and location
is required with respect to the manufactured home, unless:
(A) the home is moved from the location specified on the statement of ownership and location;
(B) the real property election is changed; or
(C) the use of the property is changed as described by Section
1201.216.
(h) The provisions of this chapter relating to the construction or installation of a manufactured home or to warranties for a manufactured home
apply to a home regardless of whether the home is considered to be real or
personal property.
(i) Notwithstanding the 60-day deadline specified in Subsection (d), if
the closing of a mortgage loan to be secured by real property including the
manufactured home is held, the loan is funded, and a deed of trust covering
the real property and all improvements on the property is recorded and the
licensed title company or attorney who closed the loan failed to complete
the conversion to real property in accordance with this chapter, the holder
or servicer of the loan may apply for a statement of ownership and location electing real property status, obtain a certified copy of the statement of
ownership and location, and make the necessary filings and notifications to
complete such conversion at any time provided that:
(1) the record owner of the home, as reflected on the department’s
records, has been given at least 60 days’ prior written notice at:
(A) the location of the home and, if it is different, the mailing
address of the owner as specified in the department records; and
(B) any other location the holder or servicer knows or believes,
after a reasonable inquiry, to be an address where the owner may have been
or is receiving mail or is an address of record;
(2) such notification shall be given by certified mail; and
(3) the department by rule shall require evidence that the holder or
servicer requesting such after-the-fact completion of a real property election
has complied with the requirements of this subsection.
Manufactured housing, when appropriately converted to real property, may be
financed as any other real property. A single wide may be moved and financed,
but a double wide may not. The reason has to do with the ability to “mate” the
two halves so that they don’t leak. The Texas Department of Housing & Community Affairs, Manufactured Housing Division requires the movers of manufactured
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Texas Law of Contracts Second Edition Update
homes to register the move. They must inform the outgoing state of its location
and where it is going.
As of July 2014, over 56,000 single and double wide manufactured homes were
sold in the United States. Many of these buyers were looking for land to install
the units, which gives the real estate agent a great business opportunity to explore.
The trend of these purchases is down from 2002, when 174,000 were sold.
Plants
Trees and crops generally fall into one of two classes:
■■ Trees, perennial shrubbery, and grasses that do not require annual cultivation
are called fructus naturales. These items are considered real estate.
■■ Annually cultivated crops such as fruit, vegetables, and grain are called
emblements, or fructus industriales, and are generally considered personal
property.
E X A M P L E A farmer who sells his farm won’t have to dig up growing
corn plants and haul them away unless the sales contract says so. The farmer can
return and harvest the corn when it’s ready. Perennial crops, such as orchards or vineyards, are not personal property and so transfer with the land.
F O R
An item of real property can become personal property by severance, or separating from the land. For example, a growing tree is real estate until the owner cuts it
down, literally severing it from the property. Similarly, an apple becomes personal
property once it is picked from a tree.
It is also possible to change personal property into real property through the process called annexation. For example, if a landowner buys cement, stones, and
sand and mixes them into concrete to construct a sidewalk across the land, the
landowner has converted personal property (cement, stones, and sand) into real
property (a sidewalk).
Real estate licensees need to know whether property is real or personal. An important distinction arises when the property is transferred from one owner to another.
Real property is conveyed by deed, while personal property is conveyed by a bill
of sale or receipt.
Classifications of Fixtures
In considering the differences between real and personal property, it is necessary
to distinguish between a fixture and personal property.
Fixtures A fixture is personal property that has been so affixed to land or a
building that, by law, it becomes part of the real property. Examples of fixtures
are heating systems, elevator equipment in highrise buildings, radiators, kitchen
cabinets, light fixtures, and plumbing. Almost any item that has been added as a
permanent part of a building is considered a fixture.
Legal Tests of a Fixture The overall test used to determine whether an item
is a fixture (real property) or personal property is a question of intent (see Figure
2.4). Did the person who installed the item intend it to remain permanently on
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Unit 2 Basics of Real Estate Law
25
the property or to be removable in the future? In determining intent, courts use
the following three basic tests:
■■ Method of annexation: How permanent is the method of attachment? Can the
item be removed without causing damage to the surrounding property?
■■ Adaptation to real estate: Is the item being used as real property or personal
property? For example, a refrigerator is usually considered personal property.
However, if a refrigerator has been adapted to match the kitchen cabinetry,
it becomes a fixture.
■■ Agreement: What is the annexor’s intention?
FIGURE 2.4: Legal Tests of a Fixture
Intent
Annexation
Adaptation
Agreement
Although these tests may seem simple, court decisions have been complex and
inconsistent. Property that appears to be permanently affixed has sometimes been
ruled to be personal property, while property that seems removable has been ruled
a fixture. It is important that an owner clarify what is to be sold with the real
estate at the very beginning of the sales process so that the details may be correctly
included in the sales contract.
P R A C T I C E At the time a property is listed, the seller and the listing agent
should discuss which items to include in the sale. The written sales contract between
the buyer and the seller should specifically list all articles that are being included in
the sale, particularly if any doubt exists as to whether they are personal property or fixtures (for example, built-in bookcases, chandeliers, ceiling fans, or exotic shrubbery).
This specificity will avoid a misunderstanding between the parties that might result in
the collapse of the transaction and expensive lawsuits. The most commonly disputed
items between buyers and sellers are draperies, light fixtures, and appliances.
I N
Trade Fixtures A special category of fixtures includes property used in the
course of business. An article owned by a tenant and attached to a rented space
or building or used in conducting a business is a trade fixture. Some examples
of trade fixtures are bowling alleys, store shelves, and barroom and restaurant
equipment. Agricultural fixtures, such as chicken coops and tool sheds, are also
included in this category. Trade fixtures must be removed on or before the last day
the property is rented. The tenant is responsible for any damage caused by the
removal of a fixture. Trade fixtures that are not removed become the real property
of the landlord.
E X A M P L E A pizza parlor leases space in a small shopping center. The
restaurateur bolted a large iron oven to the floor of the unit. When the pizza parlor goes
out of business or relocates, the restaurateur will be able to remove the pizza oven
if the bolt holes in the floor can be repaired. The oven is a trade fixture. On the other
hand, if the pizza oven was brought into the restaurant in pieces, welded together,
F O R
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Texas Law of Contracts Second Edition Update
and set in concrete, the restaurateur might not be able to remove it without causing
structural damage. In that case, the oven might become a fixture.
Trade fixtures differ from other fixtures in the following ways:
■■ Fixtures belong to the owner of the real estate, but trade fixtures are usually
owned and installed by a tenant for the tenant’s use.
■■ Fixtures are considered a permanent part of a building, but trade fixtures are
removable. Trade fixtures may be attached to a building so they appear to be
fixtures.
Legally, fixtures are real property, so they are included in any sale or mortgage.
Trade fixtures, however, are considered personal property and are not included in
the sale or mortgage of real estate, except by special agreement.
CHARACTERISTICS OF REAL PROPERTY
Four Economic
Characteristics of
Real Estate
Scarcity
Improvements
■■ Permanence of
investment
■■ Location or area
preference
■■
■■
Real property possesses seven basic characteristics that define its nature and
affect its use. These characteristics fall into two broad categories—economic and
physical.
Economic Characteristics
The four economic characteristics of land that affect its value as a product in
the marketplace are scarcity, improvements, permanence of investment, and area
preference.
Scarcity Only about a quarter of the earth’s surface is dry land; the rest is water.
The total supply of land, then, is not limitless. While a considerable amount of
land remains unused or uninhabited, the supply in a given location or of a particular quality is generally considered finite.
Improvements Building an improvement on one parcel of land can affect the
land’s value and use, as well as that of neighboring tracts and whole communities.
For example, constructing a new shopping center or selecting a site for a nuclear
power plant or toxic waste dump can dramatically change the value of land in a
large area.
Permanence of Investment The capital and labor used to build an improvement represent a large fixed investment. Although even a well-built structure
can be razed to make way for a newer building, improvements such as drainage,
electricity, water, and sewerage remain. The return on such investments tends to
be long term and relatively stable.
Area Preference Area preference, or situs (“to place”), is commonly called
“location, location, location.” This economic characteristic refers not only to
geography but also to people’s preference for a specific area. Area preference is
based on several factors, such as convenience, reputation, and history. It is the
unique quality of these preferences that results in the different price points for
similar properties. Location is often considered the single most important economic characteristic of land.
E X A M P L E A river runs through a town, dividing it more or less in half.
Houses on the north side of the river sell for an average of $170,000. On the south
F O R
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Unit 2 Basics of Real Estate Law
27
side of the river, identical houses sell for more than $200,000. The only difference is
that homebuyers think that the area south of the river is a better neighborhood, even
though no obvious difference exists between the two equally pleasant sides of town.
Schools also can contribute to area preference. With the diversity of quality education, many home buyers are selecting neighborhoods with high quality schools.
This is true for elementary, middle, and high schools. It is not unusual for an
adjoining neighborhood to have a 20% reduction in home prices because of a
lesser quality school than the other.
Physical Characteristics
Three Physical
Characteristics of
Land
Land has three physical characteristics: immobility, indestructibility, and
uniqueness.
Immobility
Indestructibility
■■ Uniqueness
Immobility It is true that some of the substances of land are removable and that
topography can be changed, but the geographic location of any given parcel of
land can never be changed. It is fixed, immobile.
■■
■■
Indestructibility Land is also indestructible. This permanence of land, coupled
with the long-term nature of improvements, tends to stabilize investments in real
property.
The fact that land is indestructible does not change the fact that the improvements on land depreciate and can become obsolete, which may dramatically
reduce the land’s value. This gradual depreciation should not be confused with
the knowledge that the economic desirability of a given location can change.
Uniqueness Uniqueness, or nonhomogeneity, is the concept that no two parcels of property are the same or in the same location. The characteristics of each
property, no matter how small, differ from those of every other. An individual
parcel has no substitute because each is unique.
FORMS OF REAL ESTATE OWNERSHIP
Licensees may provide buyers the information necessary for them to determine
the type of ownership that best fits their needs. Providing information does not
put the licensee at risk of practicing law. What the licensee may not do is advise
the buyers which form of ownership to take. The choice of ownership affects the
ability to transfer the real estate, has tax implications, and decides rights to future
claims.
Although the available forms of ownership are controlled by state laws, a fee simple estate may be held in three basic ways:
■■ In severalty, where title is held by one individual or corporation
■■ In co-ownership, where title is held by two or more individuals
■■ In trust, where a neutral individual holds title for the benefit of another
Ownership in Severalty
Ownership in severalty occurs when property is owned by one individual or corporation. The term comes from the fact that a sole owner is severed or cut off
from other owners. The severalty owner has sole rights to the ownership and sole
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discretion to sell, will, lease, or otherwise transfer part or all the ownership rights
to another person.
Co-Ownership
Forms of
Co-Ownership
Tenancy in common
Joint tenancy
■■ Tenancy by the entirety
■■ Community property
■■
■■
When title to one parcel of real estate is held by two or more individuals, those
parties are called co-owners. Most states commonly recognize various forms of
co-ownership. Individuals may co-own property as tenants in common, joint tenants, or tenants by the entirety, or they may co-own it as community property (see
Figure 2.5). The differences in the types of co-ownership only become apparent
when the property is conveyed or one of the owners dies.
FIGURE 2.5: Forms of Co-Ownership
Co-Ownerships
Property Held
Property Conveyed
Tenancy in common
Each tenant holds a fractional undivided interest.
The tenants can convey or devise
their individual interest, but not the
entire interest.
Joint tenancy
Unity of ownership.
Created by intentional
act; unities of possession,
interest, time, title.
Possible right of survivorship; cannot
be conveyed to heirs.
Community property
Husband and wife are
equal partners in marriage.
Real or personal property
acquired during marriage
is community property.
Conveyance requires signature
of both spouses. No right of survivorship; when one spouse dies,
survivor owns one-half of community
property. Other one-half is distributed according to will or, if no will,
according to state law.
Tenancy in Common A parcel of real estate may be owned by two or more people as tenants in common. In a tenancy in common, each tenant holds an undivided fractional interest in the property. Although a tenant in common may hold
one-half or one-third interest in a property, the physical property is not divided
into a specific half or third. The co-owners have unity of possession, meaning that
they are entitled to possession of the whole property. It is the ownership interest,
not the property, that is divided.
The deed creating a tenancy in common may or may not state the fractional interest held by each co-owner. If no fractions are stated, the tenants are presumed to
hold equal shares. For example, if five people hold title, each would own an undivided one-fifth interest.
Because the co-owners own separate interests, they can sell, convey, mortgage, or
transfer their individual interest without the consent of the other co-owners.
However, no individual tenant may transfer the ownership of the entire property.
When one co-owner dies, the tenant’s undivided interest passes according to the
co-owner’s will, heirs, or living trust (see Figure 2.6).
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Unit 2 Basics of Real Estate Law
29
FIGURE 2.6: Tenancy in Common
A and B are tenants
in common.
B dies and wills his interest to C and D
equally as tenants in common.
C
1/4
A
1/2
B
1 /2
A
1/2
D
1/4
When two or more people acquire title to real estate and the deed does not indicate the form of the tenancy, the new owners are usually determined to have
acquired title as tenants in common.
Joint Tenancy Most states (including Texas) recognize some form of joint tenancy in property owned by two or more people.
Joint tenancy includes the right of survivorship. Upon the death of a joint tenant, the deceased’s interest transfers directly to the surviving joint tenant or tenants. Essentially, there is one less owner.
With each successive death of a joint tenant, the surviving joint tenants keep
acquiring the deceased tenant’s interest equally. The last survivor takes title in
severalty and has all the rights of sole ownership, including the right to pass the
property to any heirs (see Figure 2.7).
FIGURE 2.7: Joint Tenancy With Right of Survivorship
1. A, B, and C are
joint tenants.
2. When C dies, A and B
remain as joint tenants.
A
A
B
B
C
A
3. When B dies, A holds
title in severalty, which
is inheritable.
D
1 /2
E
1 /2
4. A dies and wills his
interest to D and E as
tenants in common.
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I N P R A C T I C E The form under which title should be taken should be discussed with an attorney. Remember that licensees may not give legal advice or
engage in the practice of law.
Memory Tip
The Four Unities
The four unities necessary to
create a joint tenancy may be
remembered by the acronym
PITT:
■■ Possession
■■ Interest
■■ Time
■■ Title
Creating Joint Tenancies A joint tenancy can be created only by the intentional act of conveying a deed or giving the property by will or living trust. It
cannot be implied or created by operation of law. The deed must specifically state
the parties’ intention to create a joint tenancy, and the parties must be explicitly
identified as joint tenants.
To create joint tenancy, four groups or unities are needed:
■■ Unity of possession—all joint tenants holding an undivided right to
possession
■■ Unity of interest—all joint tenants holding equal ownership interests
■■ Unity of time—all joint tenants acquiring their interests at the same time
■■ Unity of title—all joint tenants acquiring their interests by the same
document
Terminating Joint Tenancies A joint tenancy is destroyed when any one of the
four unities of joint tenancy is terminated. A joint tenant is free to convey interest
in the jointly held property, but doing so destroys the unities of time and title. The
new owner cannot become a joint tenant. Rights of other joint tenants, however,
are unaffected. For example, if A, B, and C hold title as joint tenants and A conveys her interest to D, then D will own an undivided one-third interest in severalty as tenant in common with B and C, who continue to own their undivided
two-thirds interest as joint tenants (see Figure 2.8).
FIGURE 2.8: Combination of Tenancies
A, B, and C are joint tenants.
A sells her interest to D.
D
A
B
C
B
C
D becomes a tenant in common
with B and C as joint tenants.
Termination of Co-Ownership by Partition Suit Partition is a legal way to
dissolve the relationship when the parties do not voluntarily agree to its termination. If the court determines that the land cannot be divided physically into separate parcels without destroying its value, the court will order the real estate sold.
The proceeds of the sale will then be divided among the co-owners according to
their fractional interests.
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31
Community Property Rights Community property laws are based on the idea
that a husband and wife, rather than merging into one entity, are equal partners
in the marriage. Under community property laws, any property acquired during a
marriage is considered to be obtained by mutual effort. Community property law
varies widely among the states, but they all recognize two kinds of property: separate property and community property.
Separate property is real or personal property that was owned solely by either
spouse before the marriage, acquired by gift or inheritance during the marriage,
and purchased with separate funds during the marriage. Separate property can be
mortgaged or conveyed by the owning spouse without the signature of the nonowning spouse.
Community property consists of real and personal property acquired by either
spouse during the marriage. Any conveyance or encumbrance of community property requires the signatures of both spouses. Spouses can will their half of the community property to whomever they desire, but upon the death of one spouse, the
surviving spouse automatically owns one-half of the remaining property. If one
spouse dies without a will, the other half is inherited by the surviving spouse or
by the decedent’s other heirs, depending on state law. In Texas, if one spouse dies
without a will and the heirs are common to both spouses (e.g., no stepchildren),
the surviving spouse inherits the decedent’s half of the property. If the heirs are
not common to both spouses, the decedent’s half of the property is split among
the decedent’s heirs.
Trusts
A trust is a device by which one person transfers ownership of property to someone else to hold or manage for the benefit of a third party. Perhaps a grandfather
wishes to ensure the college education of his granddaughter, so he transfers his
oil field to the grandchild’s mother. He instructs the mother to use its income to
pay for the grandchild’s college tuition. In this case, the grandfather is the trustor— the person who creates the trust. The granddaughter is the beneficiary—
the person who benefits from the trust. The mother is the trustee— the party who
holds legal title to the property and is entrusted with carrying out the trustor’s
instructions regarding the purpose of the trust. The trustee’s power and authority
are limited by the terms of the trust agreement, will, or deed in trust.
I N P R A C T I C E The legal and tax implications of setting up a trust are complex and vary widely from state to state. Attorneys and tax experts should always be
consulted on the subject of trusts.
Most states (including Texas) allow real estate to be held in trust. Depending on
the type of trust and its purpose, the trustor, trustee, and beneficiary can all be
either people or legal entities, such as corporations. Trust companies are corporations set up for this specific purpose.
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OWNERSHIP OF REAL ESTATE BY BUSINESS ORGANIZATIONS
A business organization is a legal entity that exists independently of its members.
Ownership by a business organization makes it possible for many people to hold
an interest in the same parcel of real estate. Investors may be organized to finance
a real estate project in various ways. Some provide for the real estate to be owned
by the entity; others provide for direct ownership by the investors.
Partnership
A partnership is an association of two or more persons who carry on a business
for profit as co-owners. In a general partnership, all the partners participate in
the operation and management of the business and share full liability for business
losses and obligations. A limited partnership consists of one or more general partners plus a number of limited partners. The business is run by the general partner
or partners. The limited partners are not legally permitted to participate, and each
can be held liable for business losses only to the amount invested. The limited
partnership is a popular method of organizing investors because it permits investors with small amounts of capital to participate in large real estate projects with
predetermined maximum personal risk.
General partnerships are dissolved and must be reorganized if one partner dies,
withdraws, or goes bankrupt. In a limited partnership, however, the partnership
agreement may provide for the continuation of the organization following the
death or withdrawal of one of the partners.
Corporations
A corporation is a legal entity—an artificial person—created under the authority
of the laws of the state from which it receives its charter. A corporation is managed and operated by its board of directors. The charter sets forth the powers of
the corporation, including its right to buy and sell real estate (based on a resolution by the board of directors). Because the corporation is a legal entity, it can own
real estate in severalty or as a tenant in common. Some corporations are permitted
by their charters to purchase real estate for any purpose; others are limited to purchasing only the land necessary to fulfill the entities’ corporate purposes.
As a legal entity, a corporation continues to exist until it is formally dissolved. The
death of one of the officers or directors does not affect title to property owned by
the corporation.
After the corporation is formed, it is automatically an S corporation for IRS tax
purposes. The corporation can file for C status if it wishes. The S corporation has
the same tax attributes as an LLC or partnership, in that all profits and losses are
passed to the shareholder.
The reason for these elaborate processes is to avoid personal liability, but it may
be a futile attempt if the corporate formalities are not kept. This includes meetings, minutes, resolutions, votes, et cetera. Without these formalities, it is possible
to “pierce the corporate veil” and attack the shareholder individually. One of the
more popular ways is to insure the directors and officers with D&O insurance, but
care must be given to the policy provisions because there are certain things that
are generally not covered—fraud being at the top of the list.
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Unit 2 Basics of Real Estate Law
Many investors are forming fancy entities, using a combination of limited partnerships coupled with LLCs and corporations to hold properties, sometimes forming
these for each individual property. The new thinking for many is to hold the property individually and insure with a large blanket liability policy.
Limited Liability Companies
The limited liability company (LLC) is a form of business organization that combines the most attractive features of limited partnerships and corporations. The
members of an LLC enjoy the limited liability offered by a corporate form of ownership and the tax advantages of a partnership. The structure and methods of
establishing a new LLC, or of converting an existing entity to the LLC form, vary
from state to state.
CONDOMINIUMS, COOPERATIVES, TOWN HOUSES, AND TIME-SHARES
A growing urban population, diverse lifestyles, changing family structures, and
heightened mobility created a demand for new forms of ownership. Condominiums, cooperatives, town houses, and time-share arrangements are four types of
property ownership that address society’s changing real estate needs.
See Figure 2.9 for a comparison chart of these types of property ownership.
FIGURE 2.9: Four Types of Property Ownership
Type
Condomium
Cooperative
Time-Share
Description
Single units are located
in lowrise and highrise
complexes.
Single units are located in
lowrise and highrise complexes.
Multiple purchasers buy
interests in real estate—
usually resort or hotel
property. Each purchaser has
the right to use their unit for a
set time each year.
Ownership
Owners have fee title
to interior space of
units and share title to
common areas.
Tenants own shares in a corporation, partnership, or trust
that holds title to the building.
Tenants have proprietary leases
and the right to occupy their
respective units.
Time-share estate is a fee
simple interest. Time-share
use agreement is personal
property that expires after a
specified time period.
Transfer
Single units are transferred by deed, will, or
living trust.
Shares are personal property.
Shareholders may sell or
transfer shares. Transfer of
shares may be restricted by
bylaws.
An interest in a time-share
estate may be conveyed by
deed or will by the owner. An
interest in time-share use is
personal property that may
or may not be transferable
according to the contract.
Governed by
Declaration of condominium and elected board of
directors (HOA)
Bylaws of the corporation and
elected board of directors or
trustees
Developer
Condominium Ownership
The condominium form of ownership has become increasingly popular throughout the United States. Condominium laws, often called horizontal property acts,
have been enacted in every state (in Texas, this is the Uniform Condominium
Act, which is Chapter 82 of the Texas Property Code). Under these laws, the
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owner of each unit holds a fee simple title to the unit. The individual unit owners
also own a specified share of the undivided interest in the remainder of the building and land, called common elements. Common elements typically include such
items as land, courtyards, lobbies, the exterior structure, hallways, elevators, stairways, and the roof, as well as recreational facilities such as swimming pools, tennis
courts, and golf courses. The individual unit owners own these common elements
as tenants in common. State law usually provides that unit owners do not have the
same right to partition that other tenants in common have. Condominium ownership is not restricted to highrise buildings. Lowrises, town houses, and detached
structures can all be condominiums.
Owning a Condominium Once the property is established as a condominium,
each unit becomes a separate parcel of real estate that is owned in fee simple and
may be held by one or more persons in any type of ownership or tenancy recognized by state law. A condominium unit may be mortgaged like any other parcel
of real estate and may be sold whenever desired (see Figure 2.10).
FIGURE 2.10:Condominium Ownership
5
Elevator
The owner of unit 4 owns that
unit, plus an undivided
one-fifth share of the elevator,
lobby, grounds, and structure.
4
3
2
1
Grounds
Lobby
Condominium
Real estate taxes are assessed and collected on each unit as an individual property.
Default in the payment of taxes or a mortgage loan by one unit owner may result
in a foreclosure sale of that owner’s unit.
P R A C T I C E Before buying a condominium, the buyer should do as much
background research as possible. Examining association fees and rules are critical so
that the buyer understands condominium ownership. Most states allow a time frame
in which the buyer either receives and approves all documents or can be released
from the contract.
I N
Operation and Administration The condominium property is administered
by a homeowners association (HOA), which is made up of unit owners. The association can be governed by a board of directors or another official entity and can
manage the property on its own or hire a property manager.
The HOA is responsible for the maintenance, repair, cleaning, and sanitation of
the common elements and structural portions of the property. It must also maintain fire, extended-coverage, and liability insurance.
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Unit 2 Basics of Real Estate Law
35
The expenses of maintaining and operating the building are paid by the unit owners in the form of fees and assessments that are imposed and collected by the
HOA. Recurring fees (called condo fees) are paid by each unit owner. The fees
may be due monthly, quarterly, semiannually, or annually, depending on the provisions of the bylaws. Depending on state law, if the fees are not paid, the association may seek a court-ordered judgment to have the delinquent owner’s unit sold
to cover the outstanding amount or to place a lien on the property.
Assessments are special payments required of unit owners to address some specific
expense, such as a new roof. Assessments are structured like condo fees: Owners of
larger units pay proportionately higher assessments than smaller units.
Cooperative Ownership
In a cooperative, a corporation holds title to the land and the building. The corporation then offers shares of stock to prospective tenants. The price the corporation
sets for each apartment becomes the price of the stock. The purchaser becomes a
shareholder in the corporation by virtue of stock ownership and receives a proprietary lease to the apartment for the life of the corporation. Because stock is
personal property, the cooperative tenant-owners do not own real estate, as is the
case with condominiums. Instead, they own an interest in a corporation that has
only one asset: the building.
Operation and Management The operation and management of a cooperative are determined by the corporation’s bylaws. Through their control of the corporation, the shareholders of a cooperative control the property and its operation.
They elect officers and directors who are responsible for operating the corporation
and its real estate assets. Individual shareholders are obligated to abide by the
corporation’s bylaws.
An important issue in most cooperatives is the method by which shares in the corporation may be transferred to new owners. For example, the bylaws may require
that the board of directors approve any prospective shareholders. In some cooperatives, a tenant-owner must sell the stock back to the corporation at the original
purchase price so that the corporation realizes any profits when the shares are
resold.
E X A M P L E In often publicized events, a controversial celebrity may
attempt to move into a highly exclusive cooperative apartment building and is blocked
by the cooperative’s board. In refusing to allow a controversial personality to purchase
shares, the board can cite the unwanted publicity and media attention other celebrity
tenants might suffer.
F O R
Unlike in a condominium association, which has the authority to impose a lien on
the title owned by someone who defaults on maintenance payments, the burden
of any defaulted payment in a cooperative falls on the remaining shareholders. For
this reason, approval of prospective tenants by the board of directors frequently
involves financial evaluation. If the corporation is unable to make mortgage and
tax payments because of shareholder defaults, the property might be sold by court
order in a foreclosure suit. This would destroy the interests of all shareholders,
including those who have paid their assessments.
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Texas Law of Contracts Second Edition Update
Time-Share Ownership
Time-share ownership permits multiple purchasers to buy interests in real estate
and is most common with resort property ownership. Each purchaser receives the
right to use the facilities for a certain period. A time-share estate includes a fee
simple interest in a specific unit; a time-share use is a contract under which the
developer owns the real estate and establishes the rules for use of the property.
With a time-share estate, the owner’s occupancy and use of the property are limited to the contractual period purchased—for example, the 17th complete week,
Sunday through Saturday, of each calendar year. The owner is assessed for maintenance and common area expenses based on the ratio of the ownership period to
the total number of ownership periods in the property. Time-share estates theoretically never end because they are real property interests. However, the physical
life of the improvements is limited and must be looked at carefully when considering such a purchase.
The principal difference between a time-share estate and a time-share use lies in
the interest transferred to an owner by the developer of the project. A time-share
use consists of the right to occupy and use the facilities for a certain number of
years. At the end of that time, the owner’s rights in the property terminate. In
effect, the developer has sold only a right of occupancy and use to the owner, not
a fee simple interest.
Some time-sharing programs specify certain months or weeks of the year during
which the owner can use the property. Others provide a rotation system under
which the owner can occupy the unit during different times of the year in different
years. Some include a swapping privilege for transferring the ownership period to
another property to provide some variety for the owner. Time-shared properties
typically are used 50 weeks each year, with the remaining two weeks reserved for
maintenance of the improvements.
P R A C T I C E The laws governing the development and sale of time-share
units are complex and vary substantially from state to state. In addition, the sale of
time-share properties may be subject to federal securities laws, as well as a state’s
real estate commission oversight. In many states, time-share properties are now subject to subdivision requirements.
I N
LAWS AFFECTING REAL ESTATE
Laws Affecting
Real Estate
■■
■■
■■
■■
■■
■■
■■
■■
Contract law
General property law
Agency law
Real estate license law
Federal regulations
Federal, state, and local
tax laws
Zoning and land-use laws
Federal, state, and local
environmental regulations
The unique nature of real estate has given rise to an equally unique set of laws and
rights. Even the simplest real estate transaction involves a body of complex laws
that includes the law of contracts, the general property law, the law of agency, and
specific state real estate license law. Federal regulations, such as environmental
laws, as well as federal, state, and local tax laws, also play an important role in real
estate transactions. State and local land-use and zoning laws also have a significant effect on the practice of real estate.
A real estate licensee cannot be an expert in all areas of real estate law. However,
licensees should know and understand some basic principles. Perhaps most important is the ability to recognize problems that should be referred to a competent
attorney. Only attorneys are trained and licensed to prepare documents defining
or transferring rights in property and to give advice on matters of law. Under no
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Unit 2 Basics of Real Estate Law
circumstances may real estate brokers or real estate salespeople act as attorneys,
unless they are also licensed attorneys representing clients in that capacity.
Real Estate License Laws
Because real estate brokers and real estate salespeople are involved with other
people’s real estate and money, the need for regulation of their activities has long
been recognized. The purpose of real estate license law is to protect the public from fraud, dishonesty, and incompetence in real estate transactions. All 50
states, the District of Columbia, and all Canadian provinces have passed laws that
require real estate brokers and real estate salespeople to be licensed. Although
state license laws are similar in many respects, they differ in some details, such as
the amount and type of prelicensing and continuing education required.
SUMMARY
Land
■■ is the earth’s surface, where water rights are held by owners of land adjacent
to rivers, lakes, or oceans;
■■ extends downward to the center of the earth, where subsurface rights include
mineral rights and other natural resources that can be transferred separately
from surface rights;
■■ stretches upward to infinity, where air rights can be sold separately from
surface rights with some limitations to enable air travel; and
■■ includes things naturally attached ( fructus naturales) to the land, such as
trees and crops that do not need cultivation and perennial crops, orchards,
and vineyards.
Real estate includes land at, above, and below the earth’s surface, plus all things
permanently attached to the land, both natural and man-made.
Real property includes
■■ both land and real estate; and
■■ the bundle of legal rights:
——
——
——
——
——
right of possession,
right to control the property,
right of enjoyment,
right of exclusion, and
right of disposition.
Title is the right to ownership of the land, and evidence of ownership is provided
by a written document, a deed, by which title is transferred.
Appurtenance is a right or privilege associated with real property and is normally
conveyed to the new owner when the property is sold.
Personal property (chattel) includes
■■ movable items, such as furniture, cash, and bonds;
■■ manufactured homes, unless permanently affixed to land;
■■ emblements (fructus industriales), annual plantings or crops of grains, vegetables, and fruit;
■■ items of real property that become personal property by severance; and
■■ items of personal property can become real property by attachment (e.g.,
construction
materials).
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A fixture is personal property that has been affixed to the land or to a building so
that by law it becomes part of the real property.
Legal tests for a fixture include the following:
■■ Method of annexation—not easily removable
■■ Adaptation to real estate—ordinarily considered a permanent addition
■■ Agreement of the parties—what is the annexor’s intention?
Trade fixtures include property attached to the structure but used in the course of
business, such as
■■ personal property, if removed by tenant and the premises are returned to
original condition before the lease expires; and
■■ real property, if left behind by tenant. The landlord can acquire this type of
property by accession.
The characteristics of real estate include the following:
■■ Economic
—— Scarcity
—— Improvements
—— Permanence of investment
—— Location (most important)
■■ Physical
—— Immobility
—— Indestructibility
—— Nonhomogeneity, or uniqueness
Forms of real estate ownership include the following:
■■ Severalty—title held by one individual
■■ Co-ownership—title held by two or more individuals, may be:
—— Tenancy in common, where each tenant holds
■■ an undivided fractional interest with unity of possession—a right to
occupy entire property; and
■■ a right to sell, convey, mortgage, transfer, or pass by will.
—— Joint tenancy is where tenants enjoy the four unities (PITT):
■■ Unity of possession—all joint tenants have undivided right to
possession.
■■ Unity of interest—all joint tenants own an equal interest.
■■ Unity of time—all joint tenants acquire their interest at the same
time.
■■ Unity of title—title is conveyed to all joint tenants by the same
document.
Joint tenants may also enjoy the right of survivorship; upon the death of a
joint tenant, interest passes to the other joint tenant or tenants. Termination
of joint tenancy is created when any one of the four unities is destroyed.
—— Community property is generally property acquired during marriage that
is not separate property.
■■ Separate property is property owned by one spouse before marriage,
or by inheritance or gift.
■■ Community property requires the signatures of both spouses to be
conveyed. After the death of one spouse, the other spouse owns
one-half of community property and the other half is distributed
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Unit 2 Basics of Real Estate Law
39
according to deceased spouse’s will or according to state law of intestate succession.
■■ Trusts—one person (trustor) transfers ownership of property to a trustee to
manage for benefit of a third party (beneficiary).
A partnership is an association of two or more persons who carry on a business for
profit as co-owners in a general or a limited partnership, as provided by state law.
■■ In a general partnership, all partners participate in operation and management and share full liability for losses and obligations.
■■ A limited partnership has both general partners and limited partners.
—— Limited partners do not participate in running the business and are only
liable for business losses up to the amount of the individual’s investment.
A limited liability company (LLC) may offers its members the following benefits:
■■ Limited liability offered by a corporate form of ownership
■■ Tax advantages of a partnership (no double taxation)
■■ Flexible management structure without corporation requirements or restrictions on limited partnership
A corporation is chartered by the state and managed and operated by a board of
directors; able to buy and sell real estate; and exists until formally dissolved.
Condominium laws of each state outline the following:
■■ The condominium owner holds fee simple title to the airspace of a unit, as
well as an undivided share in the remainder of the building and land, called
the common elements.
■■ Common elements are owned by condominium unit owners as tenants in
common.
■■ The condominium is administered by a homeowners association of unit owners that may decide to hire an outside property management firm.
■■ Maintenance of common elements is funded by fees charged to each unit
owner; default on payment does not affect other unit owners.
■■ Condominium units may be mortgaged, sold, or willed to heirs.
■■ Unit owners may be assessed to address specific expenses.
■■ In a cooperative, title to the land and the building is held by a corporation
that sells shares of stock to prospective tenants.
■■ A purchaser of stock becomes a shareholder in the corporation and receives
a proprietary lease to the apartment for the life of the corporation.
■■ Stock is owned as personal property and not real estate.
■■ The lender may accept stock as collateral for financing, which expands the
pool of potential owners.
■■ The IRS treats a cooperative the same as houses or condominiums for tax
purposes.
A time-share permits the sale of a leasehold interest (time-share use) or deeded
ownership (time-share estate) that allows occupancy during a specific period.
Time-share ownership permits multiple purchasers to buy interests in real estate, a
form of ownership most commonly found with resort property.
Laws that affect real estate include
■■ contracts, property, agency, and real estate licensing, where all states require
real estate brokers and salespeople to be licensed with requirements differing
from state to state;
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Texas Law of Contracts Second Edition Update
■■ state and local land-use and zoning laws; and
■■ federal and state environmental regulations and tax laws. UNIT 2 REVIEW QUESTIONS
1. Real estate generally includes all the following EXCEPT
a. trees.
b. air rights.
c. annual crops.
d. mineral rights.
2. When an owner of real estate sells the property to someone else, which of the sticks in the bundle of legal
rights is the owner, as seller, using?
a. Exclusion
b. Legal enjoyment
c. Control
d. Disposition
3. The buyer and the seller of a home are debating whether a certain item is real or personal property. The
buyer says it is real property and should convey with the house; the seller says it is personal property and
would not convey without a separate bill of sale. In determining whether an item is real or personal property, a court would NOT consider which of the following?
a. The cost of the item when it was purchased
b. Whether its removal would cause severe damage to the real estate
c. Whether the item is clearly adapted to the real estate
d. Any relevant agreement of the parties in their contract of sale
4. A buyer purchased a parcel of land and immediately sold the mineral rights to an oil company. The buyer
gave up which of the following?
a. Air rights
b. Surface rights
c. Subsurface rights
d. Occupancy rights
5. A homeowner is building a new enclosed front porch on his home. A truckload of lumber that the homeowner purchased has been left in the driveway for use in building the porch. At this point, the lumber is
considered
a. real property because it will be permanently affixed to the existing structure.
b. personal property.
c. personal property waiting to become a fixture.
d. a trade or chattel fixture.
6. A man owns one of 20 town houses in fee simple, along with a 5% ownership share in the parking facilities,
recreation center, and grounds. What kind of property does he own?
a. Cooperative
b. Condominium
c. Time-share
d. Land trust
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Unit 2 Basics of Real Estate Law
41
7. According to some states, any real property that either spouse of a married couple owns at the time of the
marriage remains separate property. Further, any real property acquired by either spouse during the marriage
(except by gift or inheritance) belongs to both of them equally. What is this form of ownership called?
a. Partnership
b. Joint tenancy
c. Tenancy by the entirety
d. Community property
8. A person lives in an apartment building. The land and structures are owned by a corporation, with one
mortgage loan securing the entire property. Like the other residents, this person owns stock in the corporation and has a lease to the apartment. This type of ownership is called
a. condominium.
b. planned unit development.
c. time-share.
d. cooperative.
9. A married couple co-owns a farm and has right of survivorship. This arrangement is MOST likely
a. severalty ownership.
b. community property.
c. a tenancy in common.
d. a tenancy by the entirety.
10. Which of the following is NOT a form of co-ownership?
a. Tenancy in common
b. Ownership in severalty
c. Tenancy by the entirety
d. Community property
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3
U N I T
■■
LEARNING OBJECTIVES
Contracts Used in
Real Estate
When you have completed this unit, you will be able to
■■ distinguish between express and implied, bilateral and unilateral, and
executed and executory contracts;
explain the difference in valid, void, voidable and unenforceable contracts;
identify the essential elements of a valid contract;
explain the difference between an assignment and a novation;
give examples of what constitutes a breach of contract;
list reasons for a termination of a contract;
describe the types of contracts used in the real estate business;
describe different types of listings and how they may be terminated;
identify the information needed for a listing agreement;
compare a listing agreement and a buyer agency agreement;
define types of leasehold estates;
summarize the requirements and general conditions of a valid lease and
how it may be discharged;
■■ describe different leases and when they are used; and
■■ discuss the potential use of an option and a land contract.
■■
■■
■■
■■
■■
■■
■■
■■
■■
■■
■■
42
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Unit 3 Contracts Used in Real Estate
KEY TERMS
acceptance
assignment
bilateral contract
breach of contract
buyer agency agreement
consent
consideration
contract
counteroffer
estate at sufferance
estate at will
estate for years
estate from period to
period
exclusive-agency listing
exclusive-right-to-sell
listing
executed contract
executory contract
express contract
gross lease
ground lease
implied contract
land contract
lease
leasehold estate
lease purchase
legally competent
lessee
lessor
month-to-month tenancy
multiple listing service
(MLS)
net lease
net listing
novation
offer
offeree
offeror
oil and gas lease
open listing
option
percentage lease
rescission
reversionary right
revocation
right of first refusal
security deposit
statute of frauds
sublease
time is of the essence
unenforceable contract
unilateral contract
valid contract
void contract
voidable contract
REAL ESTATE CONTRACTS
The real estate market is driven by contracts. Both listing and buyer representation agreements are contracts. Options, escrow agreements, and leases are all
contracts. And of course the offer to purchase is the first step in finalizing a sales
contract. Whatever aspect of the real estate business is involved, licensees will be
dealing with contracts. It is important to know how a contract is created, what it
means, what is required for the parties, and what kinds of actions can end it.
CONTRACT LAW
A contract is a voluntary agreement or promise between legally competent parties, supported by legal consideration, to perform (or refrain from performing)
some legal act. The definition may be easier to understand if its various parts are
examined separately.
A contract must be
■■ voluntary—no one may be forced into a contract;
■■ an agreement or a promise—a contract is essentially a promise or set of
promises;
■■ made by legally competent parties—the parties must be viewed by the law as
capable of making a legally binding promise;
■■ supported by legal consideration—a contract must be supported by some
valuable thing that induces a party to enter into the contract and that must
be legally sufficient to support a contract; and
■■ for a legal act—no one may enter a legal contract for something illegal.
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Licensees use many types of contracts and agreements to carry out their responsibilities to sellers, buyers, and the public. The area of law that governs such agreements is called contract law.
I N P R A C T I C E Real estate licensees are required to use preprinted, preapproved forms provided by TREC. Remember that licensees cannot practice law
without a license. Both the buyer and the seller have the option of selecting their own
attorney. See Unit 1 for a list of promulgated forms.
Express and Implied Contracts
Depending on how a contract is created, it is either express or implied. In an
express contract, the parties state the terms and show their intentions in words,
either oral or written. Most real estate contracts are express contracts; they have
been committed to writing. Under the statute of frauds, certain types of contracts
must be in writing to be enforceable in a court of law. In an implied contract, the
agreement of the parties is demonstrated by their acts and conduct.
When someone enters a restaurant and orders a meal, there
is an implied contract that the customer will pay the bill when it comes. A student signing up for a three-month food plan at a college makes an express contract.
I N
P R A C T I C E
Bilateral and Unilateral Contracts
Bilateral contract
■■
Bi means two—must have
two promises.
Unilateral contract
■■
Uni means one—has only
one promise.
Contracts are classified as either bilateral or unilateral. In a bilateral contract, both
parties promise to do something; one promise is given in exchange for another. A
real estate sales contract is a bilateral contract because the seller promises to sell
a parcel of real estate and transfer title to the property to the buyer, who promises
to pay a certain sum of money for the property. An exclusive-right-to-sell listing
contract is a bilateral contract.
A unilateral contract, on the other hand, is a one-sided agreement. One party
makes a promise to entice a second party to do something. The second party is not
legally obligated to act. However, if the second party does comply, the first party is
obligated to keep the promise.
E X A M P L E A homeowner offers to pay a commission to a broker to
find a buyer for a property. The broker is not obligated to find a buyer. The property
owner is only obligated to pay a commission to the broker who finds a buyer. This is
a unilateral contract.
F O R
Executed and Executory Contracts
A contract may be classified as either executed or executory, depending on whether
the agreement is performed. An executed contract is one in which all parties have
fulfilled their promises; the contract has been performed. An executory contract
exists when one (or both) party still has an act to perform. A sales contract is an
executory contract from the time it is signed until closing; ownership has not yet
changed hands, and the seller has not received the sales price. At closing, the sales
contract is executed.
Figure 3.1 highlights the issues involved in the formation of a contract—issues
talked about in detail in this unit.
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45
FIGURE 3.1: Contract Issues
Preformation
Formation
Post-formation
Essential Elements
Classification
Discharge
Offer and acceptance, consideration, legal purpose, consent,
legal capacity
Valid, void, voidable, enforceable, unenforceable, express,
implied, unilateral, bilateral,
executory, executed
Performance, breach, remedies
(damages, specific performance, rescission)
Essential Elements of a Valid Contract
Elements of a
Contract
■■
■■
■■
■■
■■
Offer and acceptance
Consideration
Consent
Legal purpose
Legally competent parties
A contract must meet certain minimum requirements to be considered legally
valid. The following are the basic essential elements of a contract.
Offer and Acceptance There must be an offer made by one party that is
accepted by the other. The person who makes the offer is the offeror. The person
to whom an offer is made is the offeree. This requirement is also called mutual
assent. It means that there must be a “meeting of the minds”; that is, there must be
complete agreement between the parties about the purpose and terms of the contract. Courts look to the “objective intent of the parties” to determine whether
they intended to enter into a binding agreement. Most states require that the offer
and acceptance be in writing. The wording of the contract must express all the
agreed terms and must be clearly understood by the parties.
An offer is a promise made by one party, requesting something in exchange for
that promise. The offer is made with the intention that the offeror will be bound
to the terms if the offer is accepted. The terms of the offer must be definite and
specific and must be communicated to the offeree.
An acceptance is a promise by the offeree to be bound by the exact terms proposed
by the offeror. The acceptance must be communicated to the offeror. Proposing
any deviation from the terms of the offer is considered a rejection of the original
offer. This is called a counteroffer. The counteroffer must be accepted by both
parties for a contract to exist.
Besides being terminated by a counteroffer, an offer may be terminated by the
offeree’s outright rejection of it. Alternatively, an offeree may fail to accept the
offer before it expires. The offeror may revoke the offer at any time before acceptance. This revocation must be communicated to the offeree by the offeror, either
directly or through the parties’ agents. The offer is revoked if the offeree learns of
the revocation and observes the offeror acting in a manner that indicates that the
offer no longer exists. For example, if a buyer gives a seller three days to accept an
offer and on the third day the buyer’s broker calls the seller’s broker and cancels
the offer, the offer is now void.
Consideration The contract must be based on consideration. Consideration
is something of legal value offered by one party and accepted by another as an
inducement to perform or to refrain from performing some act. There must be a
definite statement of consideration in a contract to show that something of value
was given in exchange for the promise. Consideration is some interest or benefit
accruing to one party, or some loss or responsibility by the other party.
Consideration must be “good and valuable between the parties.” The courts do
not inquire into the adequacy of consideration. Adequate consideration ranges
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from as little as a promise of “love and affection” to a substantial sum of money.
Anything that has been bargained for and exchanged is legally sufficient to satisfy
the requirement for consideration. The only requirements are that the parties
agree and that no undue influence or fraud has occurred.
Consent A contract that complies with all the basic requirements may still be
either void or voidable. A contract must be entered into with consent as a free
and voluntary act of each party. Each party must be able to make a prudent and
knowledgeable decision without undue influence. A mistake, misrepresentation,
fraud, undue influence, or duress would deprive a person of that ability. If any of
these circumstances is present, the contract is voidable by the injured party. If the
other party were to sue for breach, the injured party could use lack of voluntary
assent as a defense.
Legal Purpose A contract must be for a legal purpose—that is, even with all
the other elements (consent, competent parties, consideration, and offer and
acceptance) present. A contract for an illegal purpose or an act against public
policies is not a valid contract.
Legally Competent Parties All parties to the contract must be legally competent, meaning they must be of legal age and have enough mental capacity to
understand the nature or consequences of their actions in the contract. In most
states, 18 is the age of contractual capacity.
Validity of Contracts
Valid—has all legal
elements and is fully
enforceable
■■ Void—lacks one or all elements and has no legal
force or effect
■■ Voidable—has all legal
elements and may be
rescinded or disaffirmed
■■ Unenforceable—has all
legal elements and is
enforceable only between
the parties
■■
Validity of Contracts A contract can be described as valid, void, voidable, or
unenforceable, depending on the circumstances.
A valid contract meets all the essential elements that make it legally sufficient, or
enforceable, and is binding in a court of law.
A void contract has no legal force or effect because it lacks some or all the essential elements of a contract. A contract that is void was never a legal contract. For
example, the use of a forged name in a listing contract would make the contract
void.
A voidable contract appears on the surface to be valid but may be rescinded or disaffirmed by one or both parties based on some legal principle. A voidable contract
is considered by the courts to be valid if the party who has the option to disaffirm
the agreement does not do so within a period of time. A contract with a minor, for
example, is voidable. A contract entered into by a mentally ill person is usually
voidable during the mental illness and for a reasonable period after the person has
recovered. If a contract was made under duress, with misrepresentation, under the
influence, with intent to defraud, or with a minor, it is also voidable.
P R A C T I C E Mental capacity to enter into a contract is not the same as
medical sanity. The test is whether the individual in question is capable of understanding her actions. A person may suffer from a mental illness but clearly understand the
significance of her actions. Such psychological questions require consultation with
experts.
I N
The most common situation today occurs with the more senior members of society
who may be experiencing some difficulty remembering and/or communicating details.
Agents should use great care when it is apparent that some mental faculties may be
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impaired. Although caution should be used when encouraging the customer/client to
have loved ones or trusted advisers be present, it is generally a safe harbor for the
agent. Good notes of meetings and documentation will be very helpful if there should
be a problem with a second-guessing relative or friend in the future.
An unenforceable contract may also appear on the surface to be valid; however,
neither party can sue the other to force performance. For example, an oral agreement for the sale of a parcel of real estate would be unenforceable. Because the
statute of frauds requires that real estate sales contracts be in writing, the defaulting party could not be taken to court and forced to perform. There is, however, a
distinction between a suit to force performance and a suit for damages, which is
permissible in an oral agreement. An unenforceable contract is said to be “valid
as between the parties.” This means that once the agreement is fully executed
and both parties are satisfied, neither has reason to initiate a lawsuit to force
performance.
DISCHARGE OF CONTRACTS
A contract is discharged when the agreement is terminated. The most desirable
case is when a contract terminates because it was completely performed, with all
its terms fulfilled. Contracts may be terminated for other reasons, such as a party’s
breach or default.
Performance of a Contract
Each party has certain rights and duties to fulfill. The question of when a contract
must be performed is an important factor. Many contracts call for a specific time
by which the agreed acts must be completely performed. Furthermore, some contracts provide that time is of the essence, which means that the contract must be
performed within a specified time. A party who fails to perform on time is liable
for breach of contract.
P R A C T I C E When a “time is of the essence” clause is used in a contract,
the parties may want to consult an attorney. The ramifications of a breach of a contract
in which “time is of the essence” is used can be significant. For example, a buyer
might lose escrow funds, or the seller might lose the right to enforce the contract.
I N
When a contract does not specify a date for performance, the acts it requires
should be performed within a reasonable time. The interpretation of what constitutes a reasonable time depends on the situation. Courts have sometimes declared
contracts invalid because they did not contain a time or date for performance.
Assignment
Assignment refers to a transfer of rights or duties under a contract. Generally
rights and obligations may be assigned to a third party. Obligations may be delegated, but the original party remains primarily liable unless specifically released.
Most contracts have a clause to either allow or forbid assignment.
Novation
Substitution of a new contract for an existing contract is called novation. The new
agreement may be between the same parties, or a new party may be substituted for
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Texas Law of Contracts Second Edition Update
either. The parties’ intent must be to discharge the old obligation. For example,
when a real estate purchaser assumes the seller’s existing mortgage loan, the lender
may choose to release the seller and substitute the buyer as the party primarily
liable for the mortgage debt. Or when there are many changes to a real estate contract and it is faxed several times, the contract may no longer be legible. Novation
occurs when a new, clear contract with all the accepted changes is signed by all
the parties. However difficult to read, the original contract should always be saved
in case of any later disagreement over the terms agreed upon.
Breach of Contract
A contract may be terminated if it is breached by one of the parties. A breach
of contract is a violation of any of the terms or conditions of a contract without
legal reason. Some breaches are curable, while others are not. The courts generally allow a defaulting party reasonable time to cure if there is no undue burden or
hardship on the other party. For example, a tenant pays late but will not be evicted
even though there would be a monetary penalty for the breach. An example of a
breach that is not curable is when the buyer, who has signed a buyer-broker agreement, buys a property with another agent. While not curable, there is a remedy for
the breach that may involve a small claims action up to $10,000.
Statute of Limitations Every state limits the time during which parties to a
contract may bring legal suit to enforce their rights. In Texas, the statute of limitations is four years for breach of contract. The statute of limitations varies for different legal actions, and any rights not enforced within the applicable period are lost.
Other Reasons for Termination Contracts may also be discharged or terminated when any of the following occur:
■■ Partial performance of the terms, along with a written acceptance by the
party for whom acts have not been done or to whom money is owed. For
example, if the parties agree that the work performed is close enough to
completion, they can agree that the contract is discharged even if some
minor elements remain unperformed.
■■ Substantial performance, in which one party has substantially performed on
the contract but does not complete all the details exactly as the contract
requires. Such performance may be enough to force payment, with certain
adjustments for any damages suffered by the other party. For example, where
a newly constructed addition to a home is finished except for polishing the
brass doorknobs, the contractor is entitled to the final payment.
■■ Impossibility of performance, in which an act required by the contract cannot be legally accomplished.
■■ Mutual agreement of the parties to cancel the contract.
■■ Operation of law—such as in the voiding of a contract by a minor—as a
result of fraud, due to the expiration of the statute of limitations, or because
a contract was altered without the written consent of all parties involved.
■■ Rescission—one party may cancel or terminate the contract as though it had
never been made. Cancellation terminates a contract without a return to the
original position. Rescission, however, returns the parties to their original
positions before the contract, so any monies exchanged must be returned.
Rescission is normally a contractual remedy for a breach, but a contract may
also be rescinded by the mutual agreement of the parties.
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Unit 3 Contracts Used in Real Estate
49
CONTRACTS USED IN THE REAL ESTATE BUSINESS
The written agreements most commonly used by licensees are
■■ listing agreements and buyer agency agreements,
■■ real estate sales contracts,
■■ options agreements,
■■ escrow agreements,
■■ leases,
■■ land contracts or contracts for deed, and
■■ exchange agreements.
Many states have specific guidelines for when and how real estate licensees may
prepare contracts for their consumers. These guidelines are created by state real
estate officials, court decisions, or statutes. A licensee may be permitted to fill in
the blanks on certain approved preprinted documents, such as sales contracts, as
directed by the client. No separate fee may be charged for completing the forms.
The practice of law includes preparing legal documents, such as deeds and mortgages, and offering advice on legal matters; a real estate licensee who is not a
licensed attorney cannot practice law.
Contract Forms
The contracts for the sale of residential real estate are promulgated by TREC and
must be used if prepared by real estate agents. They are:
■■ Unimproved Property Contract
■■ One to Four Family Residential Contract (Resale)
■■ New Home Contract (Incomplete Construction)
■■ New Home Contract (Completed Construction)
■■ Farm and Ranch Contract
■■ Residential Condominium Contract (Resale)
Exchange The purpose of an exchange is to defer taxes to some other time,
as the tax will be lessened or absent. For many estates, deferring until death will
result in no tax if the estate is exempt from the federal estate tax. The property
will then get a stepped-up basis and the heirs will start the cost recovery (depreciation) at the current market value. This issue becomes important when agents are
giving aggressive or conservative opinions of value for an estate because the size of
the estate must be balanced with the issue of basis.
An exchange agreement is different from a purchase in the sense that equities
are being exchanged and the properties are just the vehicle to effect the transfer.
There are three different exchange situations which require three different forms.
1. Simultaneous exchange
2. Delayed exchange
3. Reverse exchange
Great care must be given to the preparation of the contract because the operative
words in the exchange are IRS. In an audit, the IRS will look for both form and
substance.
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P R A C T I C E It is essential that both parties to a contract understand
exactly what they are agreeing to. Poorly drafted documents, especially those containing extensive legal language, may be subject to various interpretations and may
lead to litigation. The parties to a real estate transaction may wish to have sales contracts and other legal documents examined by a lawyer to ensure that the agreements
accurately reflect their intentions. When preprinted forms do not sufficiently cover special provisions in a transaction, the parties should have an attorney draft an appropriate contract. When a failed transaction ends up in the courtroom, the first question the
judge will ask is, “What does it say in writing?”
I N
Commercial Contracts
TREC does not provide promulgated forms for commercial transactions, though
the Texas Association of REALTORS® provides these forms for its members.
Listing and Buyer Agency Agreements
A listing agreement is an employment contract. It establishes the rights and obligations of the broker as agent and the seller as principal. A buyer agency contract
establishes the relationship between a buyer and the buyer’s agent.
P R A C T I C E If a contract contains any ambiguity, the courts generally
interpret the agreement against the party who prepared it.
I N
LISTING AGREEMENTS
Under both the law of agency and state license laws, only a licensed real estate
broker is authorized to represent others to list, buy, sell, exchange, or lease property. Stage agency law defines the specific duties required of an agent representing
a client. (Any party to the transaction that is not represented by the agent is a
customer.) Even though the real estate salesperson may perform most, if not all, of
the listing services, the listing remains with the broker.
A listing agreement is an employment contract between a broker and a seller for
the real estate professional services of the broker. All states, either by their statutes
of fraud or by specific rules from their real estate licensing authorities, require that
the listing agreement be in writing to be enforceable in court.
Types of Listing Agreements
Several types of listing agreements exist. The type of contract determines the specific rights and obligations of the parties (see Figure 3.2).
FIGURE 3.2: Types of Listing Agreements
Exclusive Right to Sell
Exclusive Agency
Open Listing
One broker
One broker
Multiple brokers
Broker is paid regardless of who sells the
house.
Broker is paid only if the
broker is procuring cause.
Only selling broker is paid.
Seller retains the right to sell
without obligation.
Seller retains the right to sell
without obligation.
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Unit 3 Contracts Used in Real Estate
Exclusive-Right-toSell Listing
One authorized broker-agent receives a
commission.
■■ Seller pays broker-agent
regardless of who sells
property.
■■
Open Listing
There are multiple agents.
Only the selling agent is
entitled to a commission.
■■ The seller retains the right
to sell independently
without obligation.
■■
■■
51
Exclusive-Right-to-Sell Listing In an exclusive-right-to-sell listing, one broker is appointed as the seller’s sole agent. The broker is given the exclusive right,
or authorization, to market the seller’s property. If the property is sold while the
listing is in effect, the seller must pay the broker a commission, regardless of who
sells the property. Sellers benefit from this form of agreement because the broker
feels freer to spend time and money actively marketing the property.
Exclusive-Agency Listing In an exclusive-agency listing, one broker is authorized to act as the exclusive agent of the principal. However, the seller retains the
right to sell the property without the obligation to pay the broker.
Open Listing In an open listing (also called in some areas a nonexclusive listing), the seller retains the right to employ any number of brokers as agents. The
seller is only obligated to pay a commission to the broker who successfully produces a ready, willing, and able buyer. If the seller personally sells the property
without the aid of any of the brokers, the seller is not obligated to pay a commission. The terms of an open listing still must be negotiated and put in writing
Special Listing Provisions
Multiple Listing A multiple-listing clause may be included in a listing. It is
used by brokers who are members of a local multiple listing service (MLS).
The MLS offers advantages to brokers, sellers, and buyers. Brokers develop a sizable inventory of properties to be sold and are assured a portion of the commission
if they list property or participate in the sale of another broker’s listing. Sellers
gain because the property is exposed to a larger market. Buyers gain because of
access to the variety of properties on the market.
The contractual obligations among the member brokers of an MLS vary widely.
Most MLSs require that a broker turn over new listings to the service within a
specific, fairly short period after the broker obtains the listing. Under the provisions of an MLS, a participating broker makes a unilateral offer of cooperation and
compensation to other member brokers. An offer of cooperation is not an offer
of compensation. Absent the offer of compensation in MLS, there should be an
agreement between brokers that states the amount and terms of payment. In some
commercial transactions (such as leases), payments are made periodically rather
than up front.
Technology has enhanced the benefits of MLS membership.
In addition to providing instant access to information about the status of listed properties, an MLS often offers a broad range of other useful information about mortgage
loans, real estate taxes and assessments, and municipalities and school districts.
They are equally helpful to the licensee in preparing a competitive market analysis to
determine the value of a particular property before suggesting an appropriate range
of listing price to the seller. Computer-assisted searches also help buyers select properties that best meet their needs.
I N
P R A C T I C E
Net Listing A net listing provision specifies that the seller will receive a net
amount of money from any sale, with the excess going to the listing broker as comThe broker is entitled to
mission. The broker is free to offer the property at any price greater than that net
any amount exceeding
amount. Because a net listing can create a conflict of interest between the broker’s
the seller’s stated net
fiduciary responsibility to the seller and the broker’s profit motive, it is illegal in
profit.
many states and discouraged in others.
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Net Listing
■■
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Termination of Listings
A listing agreement may be terminated under the following circumstances:
■■ When the agreement’s purpose is fulfilled, such as when a ready, willing, and
able buyer has been found
■■ When the agreement’s term expires
■■ If the property is destroyed or its use is changed by some force outside the
owner’s control, such as a zoning change or condemnation by eminent
domain
■■ If title to the property is transferred by operation of law, as in the case of the
owner’s bankruptcy or foreclosure
■■ If the broker and the seller mutually agree to cancel the listing
■■ If either the broker or the seller dies or becomes incapacitated (if the salesperson dies or becomes incapacitated, the listing is still valid)
In most states, failing to specify a definite termination date in a listing is grounds
for the suspension or revocation of a real estate license.
Some listing contracts contain a broker protection clause. This clause provides
that the property owner will pay the listing broker a commission if, within a specified number of days after the listing expires, the owner sells the property to someone the broker originally introduced to the owner.
While listing agreements are required to have a definite termination date, agency
does not, and may be terminated at any time by either party. If a seller, for any
or no reason, terminates the agent’s agency, the agent must immediately cease all
marketing. The agent should remove
■■ the lock box,
■■ the yard sign,
■■ the listing from the MLS, and
■■ the listing from the agent’s website.
Should the property sell during the term of the listing agreement, the agent must
not take any action that would block the sale in a residential transaction. If there
are issues regarding the commission, it is best to let a judge decide, with the help
of an attorney. In commercial transactions, it is possible to have an attorney file a
lis pendens which will help resolve the dispute.
The Listing Process
Before signing a contract, the broker and the seller must discuss a variety of issues.
The seller’s main concerns typically are the selling price of the property and the
net proceeds. This is the broker’s opportunity to explain the various types of listing agreements, the ramifications of different agency relationships, and the marketing services the broker provides. The seller and the listing broker must agree
on the amount of compensation to be paid for providing a ready, willing, and able
buyer and whether the compensation may be shared with an assisting broker.
Information Needed for Listing Agreements
Obtaining as many facts as possible about the property is particularly important
when the listing will be shared with other brokers through the MLS who will rely
on the information taken by the listing agent.
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Unit 3 Contracts Used in Real Estate
The information needed for a listing agreement generally includes the
■■ names and relationship of the owners;
■■ street address and legal description of the property;
■■ size, type, age, and construction of the house;
■■ number of rooms and their sizes;
■■ dimensions of the lot;
■■ current (or most recent year’s) property taxes;
■■ neighborhood amenities (schools, parks and recreational areas, churches,
and public transportation);
■■ real property, if any, to be removed from the premises by the seller and any
personal property to be included in the sale for the buyer;
■■ any additional information that would make the property more appealing
and marketable; and
■■ required disclosures regarding property conditions.
Additional financial information that the listing agent will need but that does not
necessarily appear in the MLS includes
■■ any existing loans, including the name and address of each lender, the type
of loan, the loan number, the loan balance, the interest rate, the monthly
payment which includes principal, interest, taxes, and insurance (PITI),
whether the loan may be assumed by the buyer and under what circumstances, and whether the loan may be prepaid without penalty;
■■ the possibility of seller financing;
■■ the amount of any outstanding special assessments and whether they will be
paid by the seller or assumed by the buyer; and
■■ the zoning classification of the property.
Disclosures
Most states have enacted disclosure laws requiring agents to disclose whose interests they legally represent. It is important that the seller be informed of the company’s policies regarding single agency, dual agency, and buyer agency. Some states
also have designated agency where two agents from the same company may participate in the same transaction while maintaining their agency relationship with
either the buyer or the seller. Other states may allow for a facilitator or transaction
broker that has no agency responsibility to either party.
The seller must also disclose property conditions as required by law in most states.
These disclosures cover a wide range of structural, mechanical, and other conditions. Frequently, the laws require that the seller complete a standardized form.
The Listing Contract Form
Some brokers have attorneys draft listing contract forms for their firm, while others use forms prepared by the MLS, state, or local REALTOR® associations. A
separate information sheet (also called a profile or data sheet) is prepared for submission to the MLS. The profile sheet contains all the details regarding the property, compensation to assisting brokers, and special property features. Licensees
should carefully review the specific forms used in their market area and refer to
their law for any specific requirements.
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Generally, the listing contract should contain the following information:
■■ Whether the broker may place a sign on the property and advertise. The sign
should address when the property can be shown, allowing reasonable notice
to the seller.
■■ The brokerage company name, the employing broker, and if appropriate, the
salesperson taking the listing
■■ The proposed sales price. The seller’s proceeds will be reduced by unpaid real
estate taxes, special assessments, mortgage debts, and any other outstanding
obligations.
■■ Any personal property that will convey, as well as items of real or personal
property that the seller expects to remove at the time of the sale. Items that
may later become points of negotiation include major appliances, swimming
pool and spa equipment, fireplace accessories, storage sheds, window treatments, stacked firewood, and stored heating oil.
■■ Any leased equipment—security systems, cable television boxes, water
softeners, special antennas—that will be left with the property. The seller
is responsible for notifying the equipment’s lessor of the change of property
ownership.
■■ A full legal description. The buyer’s agent will refer to this information when
preparing an offer to purchase.
■■ An anticipated closing date. The listing agreement should allow adequate
time for the paperwork involved (including the buyer’s qualification for any
financing).
■■ A closing attorney, title company, or escrow company, all of which should be
considered and retained as soon as possible. The closing agent will complete
the settlement statements, disburse the funds, and file documents to be
recorded and sent to the IRS.
■■ Evidence of ownership. A warranty deed, title insurance policy, or abstract of
title with an attorney’s opinion can be used for proof of title.
■■ All existing liens to be paid in full by the seller unless being assumed by the
buyer
■■ The circumstances under which a commission will be paid, which must be
specifically stated in the contract. The fee can be either a percentage or a flat
rate and is usually paid at closing by the closing agent.
■■ The circumstances under which the contract can be terminated
■■ Warranties by the owner. The owner is responsible for certain assurances
and disclosures. Depending on the type of deed being offered, the seller may
be responsible for purchasing title insurance. Unless the property is being
sold as is, all working systems and appliances must be in normal working
condition.
■■ A home warranty, if offered, that covers plumbing, electrical and heating
systems, water heaters, duct work, and major appliances. Coverage, deductibles, limitations, and exclusions in the contract should be clearly stated.
■■ Nondiscrimination (equal opportunity) wording. The seller must understand
that the property will be shown and offered without regard to the race, color,
religion, national origin, sex, familial status, or handicap of the prospective
buyer. State or local law may include additional protected classes.
■■ Signatures of all parties who have a legal interest in the property. If one or
more of the owners is married, the spouse’s consent and signature is required
in most states to release any marital rights.
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■■ Whether the property is in the possession of a tenant, along with the terms
of the tenancy. Instructions should be included on how the property is to be
shown to prospective buyers.
■■ Prior permission to enter into an intermediary relationship
BUYER AGENCY AGREEMENTS
Like a listing agreement, a buyer agency agreement is an employment contract.
In this case, the broker is employed as the buyer’s agent; the buyer, rather than the
seller, is the principal or client. The purpose of the agreement is to find a suitable
property. A buyer’s broker must protect the buyer’s interests at all points in the
transaction.
Buyer Representation Issues
Before signing a buyer agency agreement, a broker and a buyer must discuss several
issues. The licensee should explain the forms of agency available and the parties’
rights and responsibilities under each type. The specific services provided to a
buyer-client should be clearly explained.
Compensation issues also need to be addressed. Buyer’s agents may be compensated in the form of a flat fee for services, an hourly rate, or a percentage of the
purchase price, or by sharing the commission paid by the seller to the listing broker. The agent may require a retainer fee at the time the agreement is signed to
cover initial expenses to be applied as a credit toward any fees due at the closing.
As in any agency agreement, the source of compensation does not determine the
relationship. A buyer’s agent may be compensated by either the buyer or the seller.
Issues of compensation are always negotiable.
LEASING REAL ESTATE
A lease is a contract between an owner of real estate (the lessor) and a tenant
(the lessee). A lease is a contract to transfer the lessor’s rights to exclusive possession and use of the property to the tenant for a specified period. The lease establishes the length of time the contract is to run and the amount the lessee is to pay
for use of the property, plus other rights and obligations of the parties.
In effect, the lease agreement combines two contracts. A lease is (1) a conveyance
of a possession of the real estate and (2) a contract to pay rent and assume other
obligations. The lessor grants the lessee the right to occupy the real estate and use
it for purposes stated in the lease. In return, the landlord receives payment for use
of the premises and retains a reversionary right to possession after the lease term
expires.
The statute of frauds in Texas requires lease agreements for more than one year to
be in writing to be enforceable. In general, oral leases for one year or less that can
be performed within a year of their making are enforceable. Written leases should
be signed by both the lessor and the lessee.
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P R A C T I C E Even though an oral lease may be enforceable, it is always
better practice to put lease agreements in writing. A written lease provides concrete
evidence of the terms and conditions to which the parties have agreed.
I N
LEASEHOLD ESTATES
A tenant’s right to possess real estate for the term of the lease is called a leasehold
estate (less-than-freehold). Just as there are several types of freehold (ownership)
estates, there are different kinds of leasehold estates (see Figure 3.3).
FIGURE 3.3: Leasehold Estates
Leasehold Estates
Estate for Years
Estate from Period
to Period
Estate at Will
Estate at
Sufferance
Estate for Years
Estate (Tenancy) for
Years
■■
Any definite period
An estate for years is a leasehold estate that continues for a definite period and
always has specific starting and ending dates. When the estate expires, the lessee
is required to vacate the premises and surrender possession to the lessor. No notice
is required because the lease agreement states a specific expiration date.
Estate from Period to Period
Estate from Period
to Period (Periodic
Tenancy)
■■
■■
Indefinite term
Automatically renewing
An estate from period to period is created when the landlord and tenant enter
into an agreement for an indefinite time with no specific termination date. Such
a tenancy is usually created initially to run for a definite amount of time—for
example, month to month, week to week, or year to year—but the tenancy continues indefinitely until proper notice of termination is given. A month-to-month
tenancy, for example, is created when a tenant takes possession with no definite
termination date and pays monthly rent. Periodic tenancy is often used in residential leases.
A landlord and a tenant have agreed that the apartment can
be rented by the month without specifying the number of months the lease will run.
The lease simply continues until either the landlord or the tenant gives proper notice
to terminate.
F O R
E X A M P L E
Estate at Will
Estate (Tenancy) at
Will
■■
■■
Indefinite term
Possession with landlord’s consent
An estate at will gives the tenant the right to possess property with the landlord’s
consent for an unspecified or uncertain term; it continues until it is terminated by
either party giving proper notice. An estate at will is automatically terminated by
the death of either the landlord or the tenant.
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E X A M P L E A landlord tells a tenant that at the end of the lease someone
else will be moving into the apartment. The landlord gives the tenant the option to
continue to rent until the new tenant is ready to move. If the tenant agrees, a tenancy
at will is created.
F O R
Estate at Sufferance
Estate (Tenancy) at
Sufferance
■■
Tenant’s previously lawful
possession continued
without landlord’s consent
An estate at sufferance arises when a tenant who lawfully possessed real property
continues in possession of the premises without the landlord’s consent after the
rights expire. A tenant who “holds over” or fails to surrender possession is responsible for the payment of monthly rent at the existing terms and rate.
If a lease does not contain a holdover clause, state law typically offers three options:
■■ The landlord can accept rent offered by the tenant, thereby creating a new
tenancy under conditions of the original lease.
■■ The landlord can treat the tenant as a tenant at sufferance by either objecting to the tenant holding over or informing the tenant of such treatment,
thus creating a month-to-month or periodic tenancy.
■■ The landlord can treat the tenant as a trespasser and proceed with an eviction and damages action. Under this situation, the landlord must comply
with the notice-to-quit requirements in the lease and the state laws regarding the landlord-tenant relationship. Texas requires a three-day notice to
vacate the property before filing a Forcible Entry and Detainer. However, the
Property Code does not use the term notice to quit.
LEASE AGREEMENTS
Most states require no special wording to establish the landlord-tenant relationship, but an agency disclosure may be required. For example, an agent representing the landlord would have to disclose to a potential tenant that the agent is
representing the landlord and has no responsibility to the tenant. The law of the
state where the real estate is located must be followed to ensure the validity of the
lease.
Requirements of a Valid Lease
A lease is a contract between the lessor (landlord) and the lessee (tenant). To
be valid, a lease must meet the following requirements, which are essentially the
same as in any other contract:
■■ Capacity to contract. The parties must have the legal capacity to contract.
■■ Legal objectives. The objectives of the lease must be legal.
■■ Offer and acceptance. The parties must reach a mutual agreement on all the
terms of the contract.
■■ Consideration. The lease must be supported by valid consideration.
The leased premises should be clearly described. For most residential leases, the
street address or the apartment number is usually sufficient. If supplemental space
is part of the rental, it should be clearly identified. If the lease covers land, such as
a ground lease, then a legal description should be used.
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I N P R A C T I C E Preprinted lease agreements are usually better suited to residential leases. Commercial leases are generally more complex, have different legal
requirements, and may include complicated calculations of rent and maintenance
costs. Drafting a commercial lease—or even a complex residential lease, for that matter—may constitute the practice of law. Unless the real estate licensee is also an
attorney, legal counsel should be sought.
Possession and Use of Premises
The lessor, as the owner of the real estate, is usually bound by the “covenant of
quiet enjoyment” that the lessee can occupy the premises without interference
from the owner or anyone else. The lease usually stipulates the conditions under
which the landlord may enter the property to perform maintenance, to make
repairs, or for other stated purposes.
A lessor may restrict a lessee’s use of the premises through provisions included
in the lease, such as, “the property shall be used strictly as a residence and for no
other purpose.” Use restrictions are particularly common in leases for stores or
commercial space. In the absence of such clear limitations, a lessee may use the
premises for any lawful purpose.
Term of Lease
The term of a lease, the period for which the lease will run, should be stated precisely, including the beginning and ending dates together with a statement of the
total period of the lease. For example, a lease might run “for a term of 10 years
beginning June 1, 2015, and ending May 31, 2025.”
Security Deposit
Tenants are often required to provide a security deposit, which is held by the
landlord during the lease term. The security deposit is used if the tenant defaults
on payment of rent or destroys the premises. State law may govern how security
deposits are to be held, maximum amounts, whether interest must be paid, and
how and when they are returned. In Texas, a security deposit must be returned or
accounted for on or before the 30th day after the tenant surrenders the residential
premises, or the 60th day for commercial premises. All or part of the deposit may
be retained if no new address is given, or if money is owed and not disputed. It may
not be used by the tenant for the last month’s rent.
P R A C T I C E A lease should specify whether a payment is a security
deposit or an advance on rent. If it is a security deposit, the tenant may apply it to the
final month’s rent. Failure to return or properly account for the security deposit(s) may
expose the agency (if they hold the deposit under a property management agreement) or the owner to treble damages for the amount unreasonably withheld, plus
court costs and attorney’s fees. The general rule is that the deposit may be offset by
damage caused by the tenant, less normal wear and tear.
I N
Improvements
Neither the landlord nor the tenant is required to make any improvements to the
leased property. A tenant may make improvements with the landlord’s permission,
but any alterations usually become the property of the landlord. In commercial
leases, tenants are permitted to install trade fixtures that are required to conduct
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their business. Trade fixtures may be removed before the lease expires, provided
the tenant restores the premises to the previous condition.
Accessibility
The federal Fair Housing Act makes it illegal to discriminate against prospective tenants on the basis of physical disability. Tenants with disabilities must be
permitted to make reasonable modifications to a property at their own expense.
However, if the modifications would interfere with a future tenant’s use, the landlord may require that the premises be restored to their original condition at the
end of the lease term.
Maintenance of Premises
Most states require a lessor of residential property to maintain dwelling units in
a habitable condition. Landlords must make any necessary repairs to common
areas, such as hallways, stairs, and elevators, and maintain safety features, such as
fire sprinklers and smoke alarms. The tenant must return the premises in the same
condition they were received, with allowances for ordinary wear and tear.
Destruction of Premises
The obligation to pay rent for damaged or destroyed premises differs depending on
the type of property and the lease. Tenants are not generally required to continue
to pay rent after the leased premises are destroyed.
Assignment and Subleasing
When a tenant transfers all leasehold interests to another person, the lease has
been assigned. The new tenant is legally obligated for all the promises the original
tenant made in the lease.
When a tenant transfers some leasehold interests by leasing them to a new tenant,
the original tenant has subleased (or sublet) the property. The original tenant
remains responsible for rent being paid by the new tenant and for any damage
done to the rental during the lease term. Assignment and subleasing should be in
writing and are only allowed when a lease specifically permits them.
Options
Some leases grant the lessee the option to purchase the leased premises at a predetermined price within a certain period. The lease might also contain a right of
first refusal clause, allowing the tenant the opportunity to buy the property before
the owner accepts an offer from another party.
All the general statements concerning provisions of a lease
are controlled largely by the terms of the agreement and state law. Landlord-tenant
laws vary from state to state. Recent federal legislation requires a landlord to notify a
tenant if the landlord is at risk of foreclosure on the property.
I N
P R A C T I C E
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TYPES OF LEASES
The manner in which rent is determined indicates the type of lease that is put into
effect. There are three basic types of leases: gross lease, net lease, and percentage
lease (see Figure 3.4).
FIGURE 3.4: Types of Leases
Type of Lease
Lessee
Lessor
Gross lease
Pays basic rent
Pays property charges (taxes,
repairs, insurance, etc.)
Net lease
Pays basic rent plus all or most
property charges
May pay some property charges
Percentage lease
(commercial and
industrial)
Pays basic rent plus a percent
of gross sales (may pay
property costs)
Often pays property charges
(taxes, repairs, insurance, etc.)
In a gross lease, the tenant pays a fixed rent, and the landlord pays all taxes, insurance, repairs, utilities, and maintenance connected with the property. Residential
and commercial office leases are most often gross leases.
In a net lease, the tenant pays all or most of the property charges in addition to
the rent. The monthly rental is net income for the landlord after operating costs
have been paid. This lease is most often associated with large commercial and
industrial leases.
Either a gross lease or a net lease may be a percentage lease. This type of lease
is generally used for retail business leases. The rent is based on a minimum fixed
rental fee plus a percentage of the gross income received by the tenant doing business on the leased property.
Other Types of Leases
Variable Lease Some leases allow for increases in the rental charges during the
lease periods. A graduated lease provides for specified rent increases at set future
dates. Another is the index lease, which allows rent to be increased or decreased
periodically based on changes in the consumer price index or some other indicator.
Ground Lease When a landowner leases unimproved land to a tenant who
agrees to erect a building on the land, the lease is usually called a ground lease. It
is most often used in commercial property development. They often run for terms
of 50 to 99 years.
Sandwich Lease When a tenant subleases to a new tenant (sublessee), the
original lease between the original tenant (who becomes the sublessor) and the
landlord is called a sandwich lease.
Oil and Gas Lease When an oil company leases land to explore for oil and
gas, a special lease agreement must be negotiated with the landowner receiving a
cash payment for executing the lease. If no well is drilled within the period stated
in the lease, the lease expires. However, most oil and gas leases permit the oil
company to continue its rights for another year by paying another flat rental fee.
If oil or gas is found, the landowner usually receives a percentage of its value as a
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royalty. As long as oil or gas is obtained in significant quantities, the lease continues indefinitely.
Lease Purchase A lease purchase is used when a tenant wants to purchase
the property but is unable to do so at present. In this arrangement, the purchase
agreement is the primary consideration, and the lease is secondary. Part of the
periodic rent may be applied toward the purchase price at the time the property
goes to settlement.
Executory Contract An executory contract, for our purposes, is any contract
for the sale of real estate which has unperformed obligations in excess of 180 days,
on both sides, involving a personal residence. Any contract, such as a contract
for deed, lease option, and the like, are subject to the rules contained in Section
5 of the Texas Property Code. A reading of the statutes will inspire the parties to
comply with the spirit and letter of the act because failure to do so can and will
result in severe penalties.
Sale and Leaseback This is an arrangement whereby the owners and occupiers of property sell to an investor, lease it back, and maintain their occupancy.
This technique is usually done in commercial transactions for two main reasons.
The first is to raise capital for business operations, expansion, and/or to pay shortterm debt. The second has to do with accounting, when a depreciated asset can be
sold to bolster the net worth when required for various reasons.
DISCHARGE OF LEASES
As with any contract, a lease is discharged when the contract terminates. Termination can occur when all parties have fully performed their obligations under
the agreement. In addition, the parties may agree to cancel the lease. A tenant
who simply abandons leased property, however, remains liable for the terms of the
lease—including the rent. The lease does not generally terminate if the parties die
unless it is a lease from the owner of a life estate or is a tenancy at will. The heirs
of a deceased landlord are bound by the terms of existing valid leases.
In general, if leased real estate is sold or otherwise conveyed, the new landlord
takes the property subject to the rights of the tenants. A lease agreement may,
however, contain language that permits a new landlord to terminate existing
leases given proper notice. A tenancy may also be terminated by operation of law,
as in a bankruptcy or condemnation proceeding.
OPTIONS
Options are used to give a buyer time to assess his ability or desire to proceed with
a purchase. Option time and fees vary with the market conditions at the time of
the contract. An option gives the buyer the right to proceed but not the obligation. On the other hand, it gives the seller an obligation to sell, but he cannot
require the buyer to perform.
Residential The most-used form is the TREC-promulgated One to Four Family
Residential Contract (Resale). Paragraph 23 of the form provides the buyer an
option for a stated fee and time period, which is generally $100 to $500 for 7 to 10
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days. This period is most often used to give the buyer time to get a home inspection, negotiate repairs, and evaluate the purchase. If the buyer decides not to proceed, the buyer must affirmatively terminate the contract (there is a form for such
purpose). The mere lapse of time does not automatically terminate the contract.
Commercial The option period in commercial transactions is generally longer,
usually from 30 to 90 days. If there are to be zoning changes, then the period
would reflect the process that is required by the zoning authority. The amount
of option fee varies depending upon market conditions, but generally is several
thousand dollars.
Long Term Options may be for any period and may involve initial option fees
and possibly periodic option amounts. One to three years is not unusual in longterm options. These differ from first right of refusal in that they have a fixed purchase price, even if that price is based on an increase in price as time goes by. The
most popular index for price variation is the Consumer Price Index (CPI).
Real estate can be sold under a land contract, also called a contract for deed, an
installment contract, a land sales contract, or articles of agreement for warranty
deed. Under a typical land contract, the seller (also called the vendor) retains
legal title. The buyer (called the vendee) takes possession and gets equitable title
to the property. The buyer agrees to give the seller a down payment and pay regular monthly installments of principal and interest over a number of years. The
buyer also agrees to pay real estate taxes, insurance premiums, repairs, and upkeep
on the property. Although the buyer obtains possession under the contract, the
seller is not obligated to execute and deliver a deed to the buyer until the terms of
the contract have been satisfied. This frequently occurs when the buyer has made
enough payments to obtain a real estate loan and pay off the balance due on the
contract.
SALES CONTRACTS
The real estate sales contract is the most important document in the sale of real
estate. It establishes the legal rights and obligations of the buyer and the seller.
Depending upon the area, the contract may be called an offer to purchase, a contract of purchase and sale, a purchase agreement, an earnest money agreement, or
a deposit receipt. A detailed discussion of the components of a sales contract will
be covered in Unit 5.
SUMMARY
A contract is a voluntary, legally enforceable promise between two competent
parties to perform (or not perform) some legal act in exchange for consideration.
A contract may be
■■ express or implied by conduct of parties,
■■ required to be in writing to be enforceable in a court of law,
■■ bilateral (having obligations on both sides) or unilateral (a promise by one
side that can be accepted or rejected by the other side),
■■ executed (all parties have fulfilled their promises) or executory (one or both
parties still have an act to perform),
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■■ void if one of the essential elements is missing, or
■■ voidable if it may be rescinded or disaffirmed by one or both parties.
The essential elements of a valid contract are as follows:
■■ Agreement or promise based on an offer by one party (offeror) that is
accepted by the other (offeree)
■■ Mutual assent or meeting of the minds
■■ Counteroffer that terminates the original offer and initiates a new offer
■■ Legally competent parties of legal age who are able to understand the nature
or consequences of their actions
■■ Supported by legal consideration,
—— something of legal value, which could be love and affection, and
—— free of undue influence or fraud
■■ Concerned with a legal act
■■ Can be valid, void, or voidable, depending on circumstances
—— Valid—contains all legal elements
—— Void—not legal force or effect
—— Voidable—may be rescinded by either party
Contracts may be discharged (completed) by the following:
■■ Performance, which completes the contract terms
■■ Partial performance, if agreeable to both parties
■■ Substantial performance, depending on circumstances
■■ Impossibility of performance (required acts cannot be legally accomplished)
■■ Assignment (transfer of rights to assignee or delegation of duties)
■■ Novation (substitutes a new contract or party for the original)
■■ Breach by one of the parties without legal cause
—— Liquidated damages clause may specify the amount the seller will receive
if the buyer defaults.
■■ Failure to enforce contract within statute of limitations
■■ Mutual agreement of parties
■■ Operation of law, as when a contract is void from inception
■■ Rescission (cancellation) by one or both parties
Real estate contracts may be completed by real estate licensees if preprinted, standard contract forms are used. Real estate licensees who are not licensed attorneys
may not practice law.
Contracts used in the real estate business include
■■ listing and buyer agency agreements,
■■ real estate sales contracts,
■■ option,
■■ leases, and
■■ land contracts.
Types of listing agreements include
exclusive right-to-sell—broker paid whoever sells property,
exclusive agency—broker exclusive agent for seller,
open listing—multiple brokers,
multiple listing—shared information with other brokers, and
net listing—broker retains all over net amount to seller.
■■
■■
■■
■■
■■
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A listing agreement may be terminated when
■■ the agreement’s purpose is fulfilled,
■■ the agreement’s term expires,
■■ the property is destroyed,
■■ title to the property is transferred by operation of law (e.g., bankruptcy),
■■ the broker and the seller mutually agree to end the listing,
■■ either party dies or becomes incapacitated, and
■■ either the broker or the seller breaches the contract.
Disclosures of agency relationships and property condition are important consumer safeguards and may be required by state law. The listing contract form covers many issues.
A buyer agency agreement is similar to a listing agreement with a seller because it
establishes a relationship between broker and buyer. A buyer agent may be compensated by the buyer or through the transaction.
Lease contracts give right of possession to the tenant in return for rent. These can
be estate for years, estate from period to period, estate at will, or estate at sufferance. Requirements for a valid lease are essentially the same as for a valid contract. Lease should cover possession and use of premises, terms of lease, security
deposit, improvements, accessibility, maintenance, destruction, assignment, and
subleasing.
Types of leases include gross, net, and percentage. Other variations are variable,
ground, sandwich, oil and gas, and a lease-purchase. The lease is discharged when
the contract terminates. If the landlord dies or the property is sold, the tenant’s
rights are still protected.
An option gives an optionee the right to buy or lease a property within a certain
amount of time and is only enforceable by the optionee.
Under a land contract, the seller retains title to the property until full payment
is made. There is no mortgage; the buyer makes installment payments over time.
The sales contract is the most important document in the sale of real estate.
UNIT 3 REVIEW QUESTIONS
1. The Texas Real Estate Commission does NOT promulgate a form for which of the following situations?
a. A sale of a 10-unit apartment building
b. A duplex
c. A resale condominium
d. A 10-acre ranch
2. A contract is said to be bilateral if
a. one of the parties is a minor.
b. the contract has yet to be fully performed.
c. only one party to the agreement is bound to act.
d. all parties to the contract exchange binding promises.
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Unit 3 Contracts Used in Real Estate
3. Texas Property Code 5.008 does NOT require a property disclosure statement for
a. a duplex.
b. a seller who is over 65 years old.
c. a seller who has never lived in nor seen the property.
d. any of these.
4. A contract for deed for a period of two years is considered
a. illegal.
b. an executory contract.
c. voidable.
d. a good idea for commercial properties only.
5. Under the statute of frauds, all contracts for the sale of real estate must be
a. originated by a real estate broker.
b. on preprinted forms.
c. in writing to be enforceable.
d. accompanied by earnest money deposits.
6. A buyer signs a contract under which he is given the right to purchase a property for $30,000 any time in
the next three months. The buyer pays the current owner $500 at the time that contract is signed. Which
of the following BEST describes this agreement?
a. Contingency
b. Option
c. Installment
d. Sales
7. A seller has listed a property under an exclusive-agency listing with a broker. If the seller finds a buyer, the
seller will owe the broker
a. no commission.
b. the full commission.
c. a partial commission.
d. only reimbursement for the broker’s costs.
8. MOST states require that listing agreements contain
a. a multiple listing service (MLS) clause.
b. a definite contract termination date.
c. an automatic extension clause.
d. a broker protection clause.
9. A tenant’s tenancy for years will expire in two weeks. The tenant plans to move to a larger apartment
across town when the current tenancy expires. In order to terminate this agreement, the tenant must
a. give the landlord immediate notice or the lease will automatically renew.
b. give the landlord one week’s prior notice or the lease will automatically renew.
c. do nothing, because the agreement will terminate automatically at the end of the current term.
d. sign a lease for the new apartment, which will automatically terminate the existing lease.
10. A tenancy in which the tenant continues in possession after the lease has expired, without the landlord’s
permission, is a
a. tenancy for years.
b. periodic tenancy.
c. tenancy at will.
d. tenancy at sufferance.
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4
U N I T
■■
LEARNING OBJECTIVES
Ownership Rights and
Limitations
When you have completed this unit, you will be able to
■■ identify the limitations on ownership rights that are imposed by govern-
mental powers;
■■ define each of the types of freehold estates and the rights and limitations
each conveys;
distinguish between an estate and an encumbrance;
describe the types of encumbrances that may impact a sales contract;
explain how tax liens, mechanics’ liens, and mortgage liens are applied;
give examples of different types of easements and how they are created and
terminated;
■■ explain how an easement, an encroachment, and a license impact the use of
real estate; and
■■ discuss the types of water rights: riparian, littoral, and doctrine of prior
appropriation.
■■
■■
■■
■■
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67
KEY TERMS
accretion
ad valorem tax
avulsion
condemnation
covenants, conditions,
and restrictions
(CC&Rs)
deed restrictions
easement
easement appurtenant
easement by necessity
easement by prescription
easement in gross
eminent domain
encroachment
encumbrance
erosion
escheat
estate in land
fee simple
fee simple defeasible
fee simple determinable
fee simple subject to a
condition subsequent
freehold estate
future interest
homestead
leasehold estate
license
lien
life estate
lis pendens
littoral rights
mechanic’s lien
mortgage lien
police power
prior appropriation
pur autre vie
remainder interest
reversionary interest
riparian rights
tacking
taxation
water rights
INTERESTS IN REAL ESTATE
Ownership of a parcel of real estate is not necessarily absolute; it is dependent on
the type of interest a person holds in the property. Keep in mind that the power
of landowners to control their property relates to the landowners having a title to
the property and the bundle of legal rights that accompanies the title. Even the
most complete ownership the law allows is limited by public and private restrictions. These restrictions are intended to ensure that one owner’s use or enjoyment
of his property does not interfere with others’ use or enjoyment of their property
or with the welfare of the public.
A sales contract does not necessarily refer to any of the limitations on ownership described in this unit. Existing liens are often not known until a title search
is done in preparation for closing. An existing easement or encroachment may
create a cloud on the title that will have to be resolved to the buyer’s satisfaction
before settlement.
GOVERNMENTAL POWERS
Memory Tip
Four Government Powers
■■ Police power
■■ Eminent domain
■■ Taxation
■■ Escheat
Individual ownership rights are subject to certain powers, or rights, held by fed
eral, state, and local governments. These limitations on the ownership of real
estate are imposed for the general welfare of the community and, therefore, supersede the rights or interests of the individual. Governmental powers include police
power, eminent domain, taxation, and escheat.
Police Power
Every state has the power to enact legislation to preserve order, protect the public
health and safety, and promote the general welfare of its citizens. That authority
is called a state’s police power. The state’s authority is passed on to municipalities and counties through legislation called enabling acts. What is identified as
being in the public interest can vary considerably from state to state and region
to region. For example, a police power is used to enact environmental protection
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laws, zoning ordinances, and building codes. Regulations that govern the use,
occupancy, size, location, and construction of real estate also fall within the police
powers.
Eminent Domain
Eminent domain is the
government’s right to acquire
private property for public
use; condemnation is the
actual process of taking
property.
Eminent domain is the right of the government to acquire privately owned real
estate for public use. Condemnation is the process by which the government exercises this right, by either judicial or administrative proceedings. In the taking of
property, just compensation is to be paid to the owner, and the rights of the property owner are to be protected by due process of law. Ideally, the public agency
and the owner of the property in question agree on compensation through direct
negotiation, and the government purchases the property for a price considered fair
by the owner.
Taxation
Taxation is a charge on real estate to raise funds to meet the public needs of a government. Taxes on real estate include annual real estate taxes assessed by governmental entities, including school districts; taxes on income realized by individuals
and corporations on the sale of property; and special fees that may be levied for
special projects. Nonpayment of taxes may give government the power to claim
an interest in the property.
Escheat
Escheat (revert) is a process by which the state may acquire privately owned real
or personal property. State laws provide for ownership to transfer, or escheat, to
the state when an owner dies and leaves no heirs (as defined by the law) and
there is no will or living trust instrument that directs how the real estate is to be
distributed. In some states, real property escheats to the county where the land is
located; in other states, it becomes the property of the state. Escheat is intended
to prevent property from being ownerless or abandoned.
ESTATES IN LAND
Estates are an ownership
interest and are transferred
using a deed.
An estate in land defines the degree, quantity, nature, and extent of an owner’s
interest in real property. Many types of estates exist, but not all interests in real
estate are estates. To be an estate in land, an interest must allow possession, meaning the holding and enjoyment of the property either now or in the future, and
must be measured according to time. Historically, estates in land have been classified primarily by their length of time of possession.
Freehold estates last for an indeterminable length of time, such as for a lifetime
or forever. A freehold estate continues for an indefinite period and may be passed
along to the owner’s heirs. A life estate is based on the lifetime of a person and
ends when that individual dies. There are various types of freehold estates, which
are illustrated in Figure 4.1. Non-freehold estates are those for which the length
of time can be determined. These are called leasehold estates.
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Unit 4 Ownership Rights and Limitations
FIGURE 4.1: Freehold Estates
Freehold Estates
Fee Simple
Estate
Life Estate
Fee Simple
Defeasible
Fee Simple
Absolute
Special
Limitation with
Possibility
of Reverter
Conventional
Life Estate
Condition
Subsequent
with Right
of Re-Entry
Ordinary with
Remainder or
Reversion
Pur Autre Vie
with Remainder
or Reversion
Legal Life
Estate
Dower
Homestead
Curtesy
The type of freehold estate held by the seller does not usually present a problem
for a potential purchaser but the following descriptions provide useful background
information. A seller holding less than a fee simple estate may make conveyance
of the title a problem that will require legal assistance.
Fee Simple Estate
A fee simple estate, or fee simple absolute, is the highest interest in real estate recognized by law. Fee simple ownership is ownership in which the holder is entitled
to all rights to the property by law. This estate is intended to run forever; upon the
death of its owner, it passes to the owner’s heirs. It is limited only by public and
private restrictions, such as zoning laws and restrictive covenants.
A fee simple defeasible estate is a qualified fee estate that is subject to the occurrence or nonoccurrence of some specified event. Two categories of defeasible estates
exist: fee simple determinable and fee simple subject to a condition subsequent.
Fee Simple
Determinable
“So long as”
“While”
■■ “During”
■■
■■
A fee simple determinable is a fee simple defeasible estate that may be inherited.
This estate is qualified by a special limitation (which is an occurrence or event).
The language used to distinguish a special limitation—words such as so long as,
while, or during—is the key to creating this special limitation. The former owner
retains a possibility of reverter. If the limitation is violated, the former owner (or
heirs or successors) can reacquire full ownership with no need to go to the court.
The deed is automatically returned to the former owner.
When an owner gives land to a church, so long as the land
is used for only religious purposes, it is called a fee simple determinable. The church
has the full bundle of rights possessed by any property owner, but one of the “sticks”
in the bundle is a control “stick.” In this case, if the church ever decides to use the
land for a nonreligious purpose, the original owner has the right to reacquire the land
without going to court.
F O R
E X A M P L E
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Fee Simple Subject
to a Condition
Subsequent
■■
“on condition that”
A fee simple subject to a condition subsequent, the second type of fee simple
defeasible estate, is similar to a fee simple determinable in that an owner gives real
estate on condition of ownership, but it differs in the way the estate will terminate
if there is a violation to the condition. In fee simple determinable, the property
reverts immediately to the original owner upon violation of the limitation. In fee
simple subject to a condition subsequent, the estate does not automatically terminate upon violation of the condition of ownership. The owner has the right of
reentry but must go through the court to assert this right.
The right of entry and possibility for reverter may never take effect. If they do, it
will only be at some time in the future. Therefore, each of these rights is considered a future interest.
E X A M P L E Land given on the condition that there be no consumption of
alcohol on the premises is a fee simple subject to a condition subsequent. If alcohol is
consumed on the property, the former owner has the right to reacquire full ownership.
It will be necessary for the former owner (or the heirs or successors) to go to court to
assert that right.
F O R
Life Estate
A life estate is a freehold estate limited in duration to the life of the owner or the
life of some other designated person or persons. Unlike other freehold estates, a
life estate is not inheritable. It passes to future owners according to the provisions
of the life estate.
A life tenant is not a renter like a tenant associated with a lease. A life tenant is
entitled to the rights of ownership and can benefit from possession and ordinary
use, as well as profits arising from ownership, just as if the individual were a fee
simple owner. The life tenant’s ownership may be sold, mortgaged, or leased, but
it is always subject to the limitation of the life estate.
Pur Autre Vie A life estate may also be based on the lifetime of a person other
than the life tenant. Although a life estate is not considered an estate of inheritance, a life estate pur autre vie (for the life of another) provides for inheritance
by the life tenant’s heirs only until the death of the third party. A life estate pur
autre vie is often created for people who are physically or mentally incapacitated
in the hope of providing incentive for someone to care for them.
Remainder and Reversion The fee simple owner who creates a life estate must
plan for its future ownership. When the life estate ends, it is replaced by a fee
simple estate. The future owner of the fee simple estate may be designated in one
of two ways:
1. Remainder interest. The creator of the life estate may name a remainderman
as the person to whom the property will pass when the life estate ends.
2. Reversionary interest. The creator of the life estate may choose not to name a
remainderman. In that case, ownership is said to revert to the original owner
upon the end of the life estate.
Legal Life Estate A legal life estate is not created voluntarily by an owner.
Rather, it is a form of life estate established by state law. It becomes effective automatically when certain events occur. Dower, curtesy, and homestead are the legal
life estates currently used in some states. Community property states (like Texas)
do not use dower and curtesy.
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71
HOMESTEAD IN TEXAS
Under Texas homestead laws, a family or single person cannot be forced out of
their home as a result of creditor claims. The one exception to this claim is a
pre-existing real estate loan or mechanic’s lien, which can foreclose for defaults
and nonpayment. There is no limit on the amount of equity that is protected. If
a homestead sits on less than 10 acres in an urban setting, then it is protected.
In a rural situation, 200 acres and 100 acres are covered for a family and a single
person, respectively.
Establishing a Texas homestead does not require any formal filing. One need only
occupy exclusively to establish the deed. A family with a vacation home worth
much more than their city home, wishing to claim the vacation home as their
homestead, may have a problem. Weekend or occasional use (such as in the case
of a vacation home) may not be enough to qualify if challenged by a creditor. In
this situation, the family might have the urban home with little or no equity, with
the lake house free and clear. In case of potential anticipated financial difficulties,
a family would rearrange its finances accordingly. Even in this situation, despite
some manipulation in the finances, the courts have applied the homestead laws
liberally.
Refinancing the homestead may be done provided there is no “cash out” in homes
with less than 20% equity. Texas is the only state that only allows combined loan to
value (CLTV) up to 80%. If the home is worth $150,000, there is an existing loan
of $75,000, and the owner wants to get a home equity line of credit (HELOC), the
owner can only borrow the difference between 80% of value ($120,000), less the
existing loan ($75,000)—$45,000.
Selling a homestead may be done without fear of judgment creditors being awarded
the equity because the law allows the family or single person up to six months to
find a replacement homestead.
ENCUMBRANCES
Physical
Encumbrances
Restrictions
Easements
■■ Licenses
■■
■■
An encumbrance is a claim, charge, or liability that attaches to real estate. An
encumbrance is not an estate, so it does not allow possession. An encumbrance
may decrease the value or obstruct the use of the property. In essence, an encumbrance is a right or an interest held by someone other than the property owner
that affects title to the real estate but does not necessarily prevent a transfer of
title.
Liens
A lien is an encumbrance that is usually a monetary charge against property that
provides security for a debt. If the obligation is not repaid, the lienholder is entitled to have the debt satisfied from the proceeds of a court-ordered sale of the
debtor’s property. Real estate taxes, mortgages, and mechanics’ liens all represent
possible liens against an owner’s real estate.
A lien may be voluntary (mortgage debt) or involuntary (tax lien created by statute). Because a lien attaches to the property and would be binding to a new owner,
the value of a property could be reduced. Real estate taxes and special assessments
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generally take priority over other types of liens. Otherwise, the priority of liens is
set by state law.
Tax Lien A general real estate tax is an ad valorem tax (Latin for according
to value) charged by various government agencies and municipalities. Most state
laws exempt properties such as schools, parks, houses of worship, hospitals, and
government buildings. The percentage of value used for assessment of property
and the tax rate applied varies from one locality to another. An outstanding tax
lien would be paid first from the proceeds of a court-ordered sale of a property.
Mortgage Lien A mortgage lien (or deed of trust lien in some states) is a voluntary lien given to a lender by a borrower as security for a real estate loan. Lenders
generally require that the mortgage lien take first priority (except for a real estate
tax lien).
Mechanic’s Lien A mechanic’s lien is an involuntary lien that provides security for a person or company that has not been fully paid for labor performed or
material furnished to improve real property. State law regarding the filing and
priority of mechanics’ liens varies from state to state. In many states, the sales
contract must include cautionary language regarding the possibility of existing
mechanic’s liens.
Lis Pendens When any suit affecting the title to real estate is filed, a special
notice, knows as a lis pendens (Latin for litigation pending) is recorded. This notifies potential purchasers and lenders that there is a possible future lien on the
property.
Deed Restrictions
Deed restrictions are private restrictions that affect the use of the land. Once
placed in the deed by a previous owner, they “run with the land,” limiting the use
of the property and binding to all grantees.
Covenants, conditions, and restrictions (CC&Rs) are private agreements that
affect land use. They may be enforced by an owner of real estate and included in
the seller’s deed to the buyer. Typically, however, restrictive covenants are imposed
by a developer or subdivider to maintain specific standards in a subdivision. Such
restrictive covenants are listed in the original development plans for the subdivision filed in the public record. Disclosure of CC&Rs is normally required for all
condominium projects.
Easements
An easement is the right to use the land of another for a particular purpose. It may
exist in any portion of the real estate, including the airspace above or a right-ofway across the land.
An easement appurtenant is attached to the ownership of one parcel and allows
this owner the use of a neighbor’s land. For an easement appurtenant to exist, two
adjacent parcels of land must be owned by two different parties. The parcel over
which the easement runs is called the servient tenement; the neighboring parcel
that benefits is called the dominant tenement (see Figure 4.2).
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Unit 4 Ownership Rights and Limitations
FIGURE 4.2: Easement Appurtenant
LOT B
LOT A
Lake
Easement
Appurtenant
Public Road
The owner of Lot B has an easement appurtenant across Lot A to gain access to his property from the public road.
Lot B is dominant, and Lot A is servient.
This type of easement is an encumbrance on property and will transfer with the
deed of the dominant tenement forever unless released legally.
An easement in gross is an individual or company interest in, or right to use,
someone else’s land (see Figure 4.3). A railroad’s right-of-way is an easement in
gross, as are the rights-of-way of utility easements.
FIGURE 4.3: Easement in Gross
LOT A
LOT B
Easement in Gross
Lake
Public Road
The utility company has an easement in gross across both parcels of land for its power lines.
Creating an Easement An easement is created by a written agreement
between the parties that establishes the easement right. The creation of an easement always involves two separate parties, one of whom is the owner of the land
over which the easement runs. Two other ways for an easement to be created are
easement by necessity and easement by prescription.
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Easement by Necessity An easement that is created when an owner sells a
parcel of land that has no access to a street or public way except over the seller’s
remaining land is an easement by necessity. An easement by necessity is created
by court order, based on the principle that owners must have the right to enter
and exit their land.
Easement by Prescription If the claimant has made use of another’s land
for a certain period as defined by state law, an easement by prescription may
be acquired. The prescriptive period varies according to state law but generally
requires that the claimant’s use have been continuous, exclusive, and without the
owner’s permission.
The concept of tacking provides that successive periods of continuous occupation
by different parties may be combined (tacked) to reach the required total number
of years necessary to establish a claim for a prescriptive easement.
E X A M P L E A property is located in a state with a prescriptive period of
20 years. For the past 22 years, a neighbor has driven across the property’s front yard
several times a day to reach the neighbor’s garage from a more comfortable angle.
The neighbor has an easement by prescription.
F O R
For 25 years, another neighbor has driven across this same front yard two or three
times a year to reach that neighbor’s property when in a hurry. This neighbor does not
have an easement by prescription because the use was not continuous.
For 15 years, the next-door neighbor parked a car on the same property, next to the
garage. Six years ago, this neighbor sold the house to a person who continued to park
a car next to garage. Last year, the new neighbor acquired an easement by prescription through tacking.
Terminating an Easement An easement terminates
■■ when the need no longer exists,
■■ when the owner of either the dominant or the servient tenement becomes
sole owner and the properties are merged under one legal description,
■■ by the release of the right of easement to the owner of the servient
tenement,
■■ by the abandonment of the easement (the intention of the parties is the
determining factor), or
■■ by the nonuse of a prescriptive easement.
Note that an easement may not automatically terminate for these reasons. Certain
legal steps may be required.
Licenses
A license is a personal privilege to enter the land of another for a specific purpose.
A license differs from an easement in that it can be terminated or canceled. A
license ends with the death of either party or with the sale of the land.
Encroachments
When a building, fence, or driveway illegally extends beyond the land of its owner
or legal building lines, an encroachment occurs. An encroachment is usually
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Unit 4 Ownership Rights and Limitations
75
disclosed by either a physical inspection of the property or a spot survey. If a building encroaches on adjoining land, the neighbor may be able to either recover
damages or secure removal of the portion of the building that encroaches.
WATER RIGHTS
Whether for agricultural, recreational, or other purposes, waterfront real estate
has always been desirable. Each state has strict laws that govern the ownership
and use of water as well as the adjacent land. The laws vary among the states, but
all are closely linked to climactic and topographical conditions. Where water is
plentiful, states may rely on the simple parameters set by the common-law doctrines of riparian and littoral rights. Where water is scarce, a state may control all
but limited domestic use of water, according to the doctrine of prior appropriation.
Riparian Rights
Riparian rights are common-law rights granted to owners of land along the course
of a river, stream, or similar body of water. Although riparian rights are governed
by laws that vary from state to state, they generally include the unrestricted right
to use the water. As a rule, the only limitation on the owner’s use is that such use
cannot interrupt or alter the flow of the water or contaminate it in any way. In
addition, an owner of land that borders a non-navigable waterway, (i.e., a body of
water unsuitable for commercial boat traffic) owns the land under the water to the
exact center of the waterway. Land adjoining commercially navigable rivers, on
the other hand, is usually owned to the water’s edge, with the state holding title to
the submerged land (see Figure 4.4).
FIGURE 4.4: Riparian Rights
Nonnavigable Stream
Lot A
Navigable River
Lot B
Lot A
Lot B
Owned by
Public
Littoral Rights
Closely related to riparian rights are the littoral rights of owners whose land borders commercially navigable lakes, seas, and oceans. Owners with littoral rights
enjoy unrestricted use of available waters but own the land adjacent to the water
only up to the average high-water mark. All land below this point is owned by the
government.
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Accretion, Erosion, and Avulsion
The amount of land an individual owns may be affected by the natural action of
water. An owner is entitled to all land created through accretion—increases in
the land resulting from the deposit of soil by the water’s action.
On the other hand, an owner may lose land through erosion. Erosion is the gradual and imperceptible wearing away of the land by natural forces, such as wind,
rain, and flowing water. Fortunately, erosion usually takes hundreds or even thousands of years to have any noticeable effect on a person’s property. Flash floods or
heavy winds, however, can increase the speed of erosion.
Avulsion is the sudden removal of soil by an act of nature. It is an event that
causes the loss of land much less subtly than erosion. An earthquake or a mudslide, for example, can cause an individual’s landholding to become much smaller
very quickly.
Doctrine of Prior Appropriation
In states where water is scarce, ownership and use of water are often determined
by the doctrine of prior appropriation. Under this doctrine, the right to use any
water, with the exception of limited domestic use, is controlled by the state rather
than by the landowner adjacent to the water.
To secure water rights in prior appropriation states, a landowner must demonstrate
to a state agency that the owner’s plans are for beneficial use, such as crop irrigation. If the state’s requirements are met, the landowner receives a permit to use a
specified amount of water for the limited purpose of the beneficial use. Although
statutes governing prior appropriation vary from state to state, the priority of water
rights is usually determined by the oldest recorded permit date.
Under some state laws, once granted, water rights attach to the land of the permit
holder. The permit holder may sell a water right to another party. Issuance of a
water permit does not grant access to the water source. All access rights-of-way
over the land of another (easements) must be obtained from the property owner.
Mineral Rights
Texas is known for its rich treasures of oil and gas, with more than 1,294 oil fields
alone. With billions of dollars of oil and gas royalties at stake, property owners
are possessive about their mineral rights. However, so are buyers, and real estate
agents must not only negotiate the property and minerals, but paper it according
to the wishes of the parties. For a simple transaction where the seller is simply
insisting on reserving some or all of the minerals, there is a promulgated form
entitled Addendum for Reservation of Oil, Gas and Other Minerals. For more
complex reservation, and when the minerals have been leased, real estate agents
should advise the parties to seek competent legal counsel.
When real estate agents represent properties outside of city limits and in areas
where there is oil and gas drilling activity and leases are in place, they must be
cautious about the surface rights of the lease holders.
As in all transactions, agents must not undertake any assignment that they are
not fully qualified and trained to do and without the approval of their broker or
manager.
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77
ENVIRONMENTAL ISSUES
Real estate agents must focus on contamination in and on properties. Additionally, agents are now required to understand the energy efficiency attributes of the
properties that they are involved in selling and listing (see Figure 4.5).
FIGURE 4.5: Environmental Hazards
Urea-Formaldehyde Insulation
Asbestos Ceiling Tiles
Mold in the
House
Electromagnetic
Radiation
Dripping
PCBs
Lead-Based
Paint
Contaminated
Well Water
Radon Gas
Contaminated
Groundwater
from Nearby Landfill
Radon Gas
Carbon
Monoxide
CFCs from
Air Conditioner
Underground Storage Tanks
Residential Issues
Lead If the home was built before 1978, a Disclosure of Information on LeadBased Paint and/or Lead-Based Paint Hazards (see Figure 4.6) and the EPA pamphlet Protect Your Family from Lead In Your Home must be provided to prospective
buyers and renters by the seller or landlord. The law now requires contractors to
observe certain protocols when performing repairs, remodeling, and painting in
homes, child-care facilities, and pre-schools. To learn more, visit www.epa.gov/
lead.
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FIGURE 4.6: Disclosure of Information on Lead-Based Paint and/or Lead-Based Paint Hazard
Disclosure of Information on Lead-Based Paint and/or Lead-Based Paint Hazards
Lead Warning Statement
Every purchaser of any interest in residential real property on which a residential dwelling was built prior to 1978 is
notified that such property may present exposure to lead from lead-based paint that may place young children at risk
of developing lead poisoning. Lead poisoning in young children may produce permanent neurological damage,
including learning disabilities, reduced intelligence quotient, behavioral problems, and impaired memory. Lead
poisoning also poses a particular risk to pregnant women. The seller of any interest in residential real property is
required to provide the buyer with any information on lead-based paint hazards from risk assessments or inspections
in the seller’s possession and notify the buyer of any known lead-based paint hazards. A risk assessment or inspection
for possible lead-based paint hazards is recommended prior to purchase.
Seller’s Disclosure
(a) Presence of lead-based paint and/or lead-based paint hazards (check (i) or (ii) below):
(i) ______ Known lead-based paint and/or lead-based paint hazards are present in the housing
(explain).
_______________________________________________________________________________________
(ii) _____ Seller has no knowledge of lead-based paint and/or lead-based paint hazards in the housing.
(b) Records and reports available to the seller (check (i) or (ii) below):
(i) ______ Seller has provided the purchaser with all available records and reports pertaining to leadbased paint and/or lead-based paint hazards in the housing (list documents below).
_______________________________________________________________________________________
(ii) _____ Seller has no reports or records pertaining to lead-based paint and/or lead-based paint
hazards in the housing.
Purchaser’s Acknowledgment (initial)
(c) ________ Purchaser has received copies of all information listed above.
(d) ________ Purchaser has received the pamphlet Protect Your Family from Lead in Your Home.
(e) Purchaser has (check (i) or (ii) below):
(i) _____ received a 10-day opportunity (or mutually agreed upon period) to conduct a risk assessment or inspection for the presence of lead-based paint and/or lead-based paint hazards; or
(ii) _____ waived the opportunity to conduct a risk assessment or inspection for the presence of
lead-based paint and/or lead-based paint hazards.
Agent’s Acknowledgment (initial)
(f) ________ Agent has informed the seller of the seller’s obligations under 42 U.S.C. 4852(d) and is
aware of his/her responsibility to ensure compliance.
Certification of Accuracy
The following parties have reviewed the information above and certify, to the best of their knowledge, that the
information they have provided is true and accurate.
__________________________________________________
Seller
Date
__________________________________________________
Purchaser
Date
__________________________________________________
Agent
Date
__________________________________________________
Seller
Date
__________________________________________________
Purchaser
Date
__________________________________________________
Agent
Date
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79
Indoor Air Quality (IAQ) Many homeowners are purchasing better furnace filters and are changing them in the recommended time. This results in cost savings
and increased comfort. Many utility companies in Texas will perform an inspection and energy audit at little or no cost to insure the best possible IAQ.
Understanding efficiency is also important. Where cooling is concerned, seasonal energy efficiency ratio (SEER) should be considered, balancing cost with
energy savings. Where heating is concerned, the annual fuel utilization efficiency
(AFUE) should be considered.
Commercial Issues
Many lenders of commercial properties require a Phase I environmental site assessment. This assessment involves a visual inspection of the property along with
determining the historical use of the property. If the property is next to an old gas
station, then the subject property may be suspect. If the property shows any signs
of contamination, then a Phase II assessment will be required. This assessment
involves soil samples and analysis to determine the significance of the contamination. If the contamination is toxic, then a Phase III assessment may be necessary,
involving remediation.
SUMMARY
Governmental powers can be recalled by using the acronym PETE:
■■ Police power is the state’s authority—passed down to municipalities and
counties through enabling acts—to enact nondiscriminatory legislation to
—— preserve order,
—— protect the public health and safety, and
—— promote the general welfare of citizens.
■■ Eminent domain is the government’s right to acquire privately owned real
estate for a public or economically beneficial use through
—— condemnation, a process that begins with a judicial or an administrative
proceeding, or
—— just compensation, which must be paid to the property owner.
■■ Taxation is a charge on real estate to raise funds to meet public needs.
■■ Escheat occurs when the deceased has no will or lawful heirs.
A freehold estate lasts for an indeterminable length of time:
■■ Fee simple is the highest estate recognized by law.
■■ Fee simple defeasible is a qualified estate subject to occurrence or nonoccurrence of some specified event.
■■ Life estate is based on the lifetime of a person.
An encumbrance is a claim, charge, or liability that attaches to real estate. There
are numerous types of encumbrances:
■■ A monetary encumbrance is a lien. Liens are charges against property that
provide security for a debt or obligation of the property owner. Specific liens
include
—— Tax lien—based on ad valorem tax,
—— Mortgage lien—provides security for real estate loan, and
—— Mechanic’s lien—provides security for company not paid for services or
supplies
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■■ Covenants, conditions, and restrictions (CC&Rs) are private agreements
that affect the use of land.
■■ Easements are rights to use the land of another:
—— An appurtenant easement is said to run with the land when title is
transferred.
—— An easement in gross is an individual or company interest in or right to
use another’s land.
—— An easement by necessity arises when land has no access to a street or
public way.
—— An easement by prescription is acquired when a claimant has used
another’s land for 10 to 21 years. The use must be visible, open, and
notorious.
—— An easement is usually created by written agreement between the
parties.
An easement is terminated
■■ when the need no longer exists,
■■ when the owner of either the dominant or the servient tenement becomes
the sole owner,
■■ when the owner of a servient tenement releases the right of easement,
■■ if the easement is abandoned, or
■■ the nonuse of prescriptive easement.
License is a personal privilege to enter the land of another for a specific purpose.
Encroachment occurs when all or part of a structure illegally intrudes on the land
of another or beyond legal building lines.
Water rights are determined by common law and statute:
■■ Riparian rights are common-law rights granted to owners of land along riv-
ers, streams, or similar bodies of water.
■■ Littoral rights belong to owners of land that borders commercially navigable
lakes, seas, and oceans.
■■ The doctrine of prior appropriation in some states provides that water use,
aside from limited domestic use, is controlled by the state rather than the
landowner adjacent to the water; to use the water, the landowner must demonstrate beneficial use of the water, such as irrigation of crops.
Environmental issues are as follows:
■■ Federal or state law may require certain environmental disclosure.
■■ Potential buyers may make contracts contingent on inspection for various
hazardous substances.
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Unit 4 Ownership Rights and Limitations
81
UNIT 4 REVIEW QUESTIONS
1. A purchaser of real estate learns that his ownership rights could continue forever and that no other person
can claim to be the owner or have any ownership control over the property. This person owns a
a. fee simple interest.
b. life estate.
c. determinable fee.
d. condition subsequent.
2. A person owned the fee simple title to a vacant lot adjacent to a hospital and was persuaded to make a gift
of the lot. She wanted to have some control over its use, so her attorney prepared her a deed to convey
ownership of the lot to the hospital “so long as it is used for hospital purposes.” After completion of the gift,
the hospital will own a
a. fee simple absolute estate.
b. license.
c. fee simple determinable.
d. leasehold estate.
3. Which of the following is NOT an example of governmental power?
a. Dedication
b. Police power
c. Eminent domain
d. Taxation
4. Which of the following is a legal life estate?
a. Leasehold
b. Fee simple absolute
c. Homestead
d. Determinable fee
5. An owner conveys ownership of her residence to her church but reserves for herself a life estate in the residence. The future interest held by the church is a
a. pur autre vie.
b. remainder.
c. reversion.
d. leasehold.
6. A homeowner may be allowed certain protection from judgments of creditors as a result of the state’s
a. littoral rights.
b. curtesy rights.
c. homestead rights.
d. dower rights.
7. The type of easement that is a right-of-way for a utility company’s power lines is
a. an easement in gross.
b. an easement by necessity.
c. an easement by prescription.
d. a nonassignable easement.
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8. A landowner has divided much of his land into smaller parcels and has recently sold a tract near a nature
preserve that is landlocked and cannot be entered except through one of the other tracts. The buyer of that
property will probably be granted what type of easement by court action?
a. Easement by necessity
b. Easement in gross
c. Easement by prescription
d. Easement by condemnation
9. The highest interest a person may have in real estate is
a. fee simple absolute.
b. a life estate.
c. determinable fee.
d. estate for years.
10. A Phase I environmental site assessment is generally associated with
a. remediation of lead-based paint in 1–4 family homes.
b. the rules for remodeling any dwelling that houses or teaches children.
c. a commercial property purchase.
d. the process a developer must undergo before lots and/or houses may be sold.
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5
U N I T
■■
LEARNING OBJECTIVES
The Sales Contract
When you have completed this unit, you will be able to
■■
■■
■■
■■
■■
■■
■■
■■
■■
list the details included in a sales contract;
describe the process of offer and acceptance of a sales contract;
explain the process involved in making a counteroffer;
define statute of frauds and parole evidence and their use;
identify types of personal and financial information that may be included in
the sales contract;
describe the three methods that are used for a legal description of property;
discuss the financing information that should be included in a contract;
review the purpose and disposition of an earnest money deposit; and
discuss the ramifications of default or breach of contract.
KEY TERMS
acceptance
base line
commingling
contract of sale
counteroffer
cross-hatch
disclosure
earnest money
equitable title
legal description
letter of intent (LOI)
liquidated damages
lot and block
metes and bounds
monument
offer to purchase
plat map
point of beginning (POB)
preapproval letter
principal meridian
range
rectangular survey system
school section
section
subdivision plat
suit for specific
performance
survey
tort
township
township line
township tier
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INTRODUCTION
A real estate sales contract contains the complete agreement between a buyer of
a parcel of real estate and the seller. It is an offer to purchase real estate as soon as
it has been prepared and signed by the purchaser. Depending on the state or locality, this agreement may be called an offer to purchase, contract of purchase and sale,
earnest money agreement, deposit receipt, or other variations of these terms. While
there are different contracts depending on the type of sale, the sales contract used
most often in Texas is published by the Texas Real Estate Commission (TREC)
and is called the One to Four Family Residential Contract (Resale) (see Figure
5.1). Whatever the document is called, when it has been prepared and signed by
the purchaser, it is an offer to purchase the subject real estate. Both the public and
licensees often refer to this offer to purchase as a “contract,” but only after the
document is accepted and signed by the seller, does it become a contract of sale,
or sales contract.
The contract of sale is the most important document in the sale of real estate
because it sets out in detail the agreement between the buyer and the seller and
establishes the legal rights and obligations of both parties.
In addition to the essential elements required for any contract, details that typically appear in contracts for the purchase of property include
■■ the sales price and terms;
■■ a legal description of the land;
■■ a statement of the kind and condition of the title and the form of deed to be
delivered by the seller;
■■ the kind of title evidence required, who will provide it, and how many
defects in the title will be eliminated;
■■ a statement of all the terms and conditions of the agreement between the
parties; and
■■ any contingencies.
THE PROCESS
Offer and Acceptance
Offer A broker lists an owner’s real estate for sale at whatever price and conditions the owner sets. When a prospective buyer is found, the buyer’s agent helps
that consumer prepare an offer to purchase. The offer is signed by the prospective
buyer and presented by the listing broker to the seller. In states that allow dual
agency, the same agent may represent both parties, both in preparing the offer to
purchase and in making the presentation to the seller. Traditionally the listing
broker makes all presentations to the seller, but on some occasions a buyer’s agent
may be permitted to make the presentation.
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Unit 5 The Sales Contract
FIGURE 5.1: One to Four Family Residential Contract (Resale)
Contract Concerning
EQUAL HOUSING
OPPORTUNITY
Page of 9
(Address
of Property)
PROMULGATED BY THE
TEXAS
REAL ESTATE COMMISSION (TREC)
4-28-2014
ONE TO FOUR FAMILY RESIDENTIAL CONTRACT (RESALE)
NOTICE: Not For Use For Condominium Transactions
1. PARTIES: The parties to this contract are
(Seller) and
(Buyer).
Seller agrees to sell and convey to Buyer and Buyer agrees to buy from Seller the Property defined
below.
2. PROPERTY: The land, improvements and accessories are collectively referred to as the “Property”.
A. LAND: Lot
Block
,
Addition, City of
, County of
,
Texas, known as
(address/zip code), or as described on attached exhibit.
B. IMPROVEMENTS: The house, garage and all other fixtures and improvements attached to the
above-described real property, including without limitation, the following permanently installed
and built-in items, if any: all equipment and appliances, valances, screens, shutters, awnings,
wall-to-wall carpeting, mirrors, ceiling fans, attic fans, mail boxes, television antennas, mounts
and brackets for televisions and speakers, heating and air-conditioning units, security and fire
detection equipment, wiring, plumbing and lighting fixtures, chandeliers, water softener system,
kitchen equipment, garage door openers, cleaning equipment, shrubbery, landscaping, outdoor
cooking equipment, and all other property owned by Seller and attached to the above described
real property.
C. ACCESSORIES: The following described related accessories, if any: window air conditioning units,
stove, fireplace screens, curtains and rods, blinds, window shades, draperies and rods, door keys,
mailbox keys, above ground pool, swimming pool equipment and maintenance accessories,
artificial fireplace logs, and controls for: (i) garage doors, (ii) entry gates, and (iii) other
improvements and accessories.
D. EXCLUSIONS: The following improvements and accessories will be retained by Seller and must
be removed prior to delivery of possession:
.
3. SALES PRICE:
A. Cash portion of Sales Price payable by Buyer at closing .............................. $
B. Sum of all financing described below (excluding any loan funding
fee or mortgage insurance premium) ...................................................... $
C. Sales Price (Sum of A and B) ................................................................... $
4. FINANCING (Not for use with reverse mortgage financing): The portion of Sales Price not
payable in cash will be paid as follows: (Check applicable boxes below)
 A.THIRD PARTY FINANCING: One or more third party mortgage loans in the total amount of
$_______
(excluding any loan funding fee or mortgage insurance premium).
(1) Property Approval: If the Property does not satisfy the lenders' underwriting requirements for
the loan(s) (including, but not limited to appraisal, insurability and lender required repairs),
Buyer may terminate this contract by giving notice to Seller prior to closing and the earnest
money will be refunded to Buyer.
(2) Credit Approval: (Check one box only)
 (a) This contract is subject to Buyer being approved for the financing described in the attached
Third Party Financing Addendum for Credit Approval.
 (b) This contract is not subject to Buyer being approved for financing and does not involve FHA
or VA financing.
 B. ASSUMPTION: The assumption of the unpaid principal balance of one or more promissory notes
described in the attached TREC Loan Assumption Addendum.
 C. SELLER FINANCING: A promissory note from Buyer to Seller of $
, secured by
vendor's and deed of trust liens, and containing the terms and conditions described in the attached
TREC Seller Financing Addendum. If an owner policy of title insurance is furnished, Buyer shall
furnish Seller with a mortgagee policy of title insurance.
Initialed for identification by Buyer
and Seller
TREC NO. 20-12
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FIGURE 5.1: One to Four Family Residential Contract (Resale) (continued)
Contract Concerning
(Address of Property)
Page 2 of 9
4-28-2014
5. EARNEST MONEY: Upon execution of this contract by all parties, Buyer shall deposit
$
as earnest money with
, as escrow
agent, at
(address). Buyer
shall deposit additional earnest money of $
with escrow agent within
days after the effective date of this contract. If Buyer fails to deposit the earnest money as
required by this contract, Buyer will be in default.
6. TITLE POLICY AND SURVEY:
A. TITLE POLICY: Seller shall furnish to Buyer at  Seller’s  Buyer’s expense an owner policy
of title insurance (Title Policy) issued by
(Title
Company) in the amount of the Sales Price, dated at or after closing, insuring Buyer against
loss under the provisions of the Title Policy, subject to the promulgated exclusions (including
existing building and zoning ordinances) and the following exceptions:
(1) Restrictive covenants common to the platted subdivision in which the Property is located.
(2) The standard printed exception for standby fees, taxes and assessments.
(3) Liens created as part of the financing described in Paragraph 4.
(4) Utility easements created by the dedication deed or plat of the subdivision in which the
Property is located.
(5) Reservations or exceptions otherwise permitted by this contract or as may be approved
by Buyer in writing.
(6) The standard printed exception as to marital rights.
(7) The standard printed exception as to waters, tidelands, beaches, streams, and related
matters.
(8) The standard printed exception as to discrepancies, conflicts, shortages in area or boundary
lines, encroachments or protrusions, or overlapping improvements: (i) will not be
amended or deleted from the title policy; (ii) will be amended to read, "shortages in area"
at the expense of Buyer Seller.
B. COMMITMENT: Within 20 days after the Title Company receives a copy of this contract,
Seller shall furnish to Buyer a commitment for title insurance (Commitment) and, at Buyer's
expense, legible copies of restrictive covenants and documents evidencing exceptions in the
Commitment (Exception Documents) other than the standard printed exceptions. Seller
authorizes the Title Company to deliver the Commitment and Exception Documents to Buyer
at Buyer's address shown in Paragraph 21. If the Commitment and Exception Documents are
not delivered to Buyer within the specified time, the time for delivery will be automatically
extended up to 15 days or 3 days before the Closing Date, whichever is earlier. If, due to
factors beyond Seller’s control, the Commitment and Exception Documents are not delivered
within the time required, Buyer may terminate this contract and the earnest money will be
refunded to Buyer.
C. SURVEY: The survey must be made by a registered professional land surveyor acceptable to
the Title Company and Buyer’s lender(s). (Check one box only)
(1) Within
days after the effective date of this contract, Seller shall furnish to Buyer
and Title Company Seller's existing survey of the Property and a Residential Real Property
Affidavit promulgated by the Texas Department of Insurance (T-47 Affidavit). If Seller
fails to furnish the existing survey or affidavit within the time prescribed, Buyer
shall obtain a new survey at Seller's expense no later than 3 days prior to Closing
Date. If the existing survey or affidavit is not acceptable to Title Company or Buyer's
lender(s), Buyer shall obtain a new survey at Seller's Buyer's expense no later than 3
days prior to Closing Date.
(2) Within
days after the effective date of this contract, Buyer shall obtain a new
survey at Buyer's expense. Buyer is deemed to receive the survey on the date of actual
receipt or the date specified in this paragraph, whichever is earlier.
(3) Within
_ days after the effective date of this contract, Seller, at Seller's expense
shall furnish a new survey to Buyer.
D. OBJECTIONS: Buyer may object in writing to defects, exceptions, or encumbrances to title:
disclosed on the survey other than items 6A(1) through (7) above; disclosed in the
Commitment other than items 6A(1) through (8) above; or which prohibit the following use
or activity:
.
Buyer must object the earlier of (i) the Closing Date or (ii) _
days after Buyer receives
the Commitment, Exception Documents, and the survey. Buyer’s failure to object within the
time allowed will constitute a waiver of Buyer’s right to object; except that the requirements
in Schedule C of the Commitment are not waived by Buyer. Provided Seller is not obligated
to incur any expense, Seller shall cure the timely objections of Buyer or any third party lender
Initialed for identification by Buyer
and Seller
TREC NO. 20-12
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Unit 5 The Sales Contract
FIGURE 5.1: One to Four Family Residential Contract (Resale) (continued)
Contract Concerning
(Address of Property)
Page 3 of 9
4-28-2014
within 15 days after Seller receives the objections and the Closing Date will be extended as
necessary. If objections are not cured within such 15 day period, this contract will terminate
and the earnest money will be refunded to Buyer unless Buyer waives the objections.
E. TITLE NOTICES:
(1) ABSTRACT OR TITLE POLICY: Broker advises Buyer to have an abstract of title covering
the Property examined by an attorney of Buyer’s selection, or Buyer should be furnished
with or obtain a Title Policy. If a Title Policy is furnished, the Commitment should be
promptly reviewed by an attorney of Buyer’s choice due to the time limitations on Buyer’s
right to object.
(2) MEMBERSHIP IN PROPERTY OWNERS ASSOCIATION(S): The Property is is not subject
to mandatory membership in a property owners association(s). If the Property is subject
to mandatory membership in a property owners association(s), Seller notifies Buyer under
§5.012, Texas Property Code, that, as a purchaser of property in the residential
community identified in Paragraph 2A in which the Property is located, you are obligated
to be a member of the property owners association(s). Restrictive covenants governing
the use and occupancy of the Property and all dedicatory instruments governing the
establishment, maintenance, or operation of this residential community have been or will
be recorded in the Real Property Records of the county in which the Property is located.
Copies of the restrictive covenants and dedicatory instruments may be obtained from the
county clerk. You are obligated to pay assessments to the property owners
association(s). The amount of the assessments is subject to change. Your failure
to pay the assessments could result in enforcement of the association’s lien on
and the foreclosure of the Property.
Section 207.003, Property Code, entitles an owner to receive copies of any document that
governs the establishment, maintenance, or operation of a subdivision, including, but not
limited to, restrictions, bylaws, rules and regulations, and a resale certificate from a
property owners' association. A resale certificate contains information including, but not
limited to, statements specifying the amount and frequency of regular assessments and
the style and cause number of lawsuits to which the property owners' association is a
party, other than lawsuits relating to unpaid ad valorem taxes of an individual member of
the association. These documents must be made available to you by the property owners'
association or the association's agent on your request.
If Buyer is concerned about these matters, the TREC promulgated Addendum for
Property Subject to Mandatory Membership in a Property Owners Association(s)
should be used.
(3) STATUTORY TAX DISTRICTS: If the Property is situated in a utility or other statutorily
created district providing water, sewer, drainage, or flood control facilities and services,
Chapter 49, Texas Water Code, requires Seller to deliver and Buyer to sign the statutory
notice relating to the tax rate, bonded indebtedness, or standby fee of the district prior to
final execution of this contract.
(4) TIDE WATERS: If the Property abuts the tidally influenced waters of the state, §33.135,
Texas Natural Resources Code, requires a notice regarding coastal area property to be
included in the contract. An addendum containing the notice promulgated by TREC or
required by the parties must be used.
(5) ANNEXATION: If the Property is located outside the limits of a municipality, Seller notifies
Buyer under §5.011, Texas Property Code, that the Property may now or later be included
in the extraterritorial jurisdiction of a municipality and may now or later be subject to
annexation by the municipality. Each municipality maintains a map that depicts its
boundaries and extraterritorial jurisdiction. To determine if the Property is located within a
municipality’s extraterritorial jurisdiction or is likely to be located within a municipality’s
extraterritorial jurisdiction, contact all municipalities located in the general proximity of
the Property for further information.
(6) PROPERTY LOCATED IN A CERTIFICATED SERVICE AREA OF A UTILITY SERVICE
PROVIDER: Notice required by §13.257, Water Code: The real property, described in
Paragraph 2, that you are about to purchase may be located in a certificated water or
sewer service area, which is authorized by law to provide water or sewer service to the
properties in the certificated area. If your property is located in a certificated area there
may be special costs or charges that you will be required to pay before you can receive
water or sewer service. There may be a period required to construct lines or other
facilities necessary to provide water or sewer service to your property. You are advised to
determine if the property is in a certificated area and contact the utility service provider
to determine the cost that you will be required to pay and the period, if any, that is
required to provide water or sewer service to your property. The undersigned Buyer
hereby acknowledges receipt of the foregoing notice at or before the execution of a
binding contract for the purchase of the real property described in Paragraph 2 or at
closing of purchase of the real property.
Initialed for identification by Buyer
and Seller
TREC NO. 20-12
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FIGURE 5.1: One to Four Family Residential Contract (Resale) (continued)
Contract Concerning
(Address of Property)
Page 4 of 9
4-28-2014
(7) PUBLIC IMPROVEMENT DISTRICTS: If the Property is in a public improvement district,
§5.014, Property Code, requires Seller to notify Buyer as follows: As a purchaser of this
parcel of real property you are obligated to pay an assessment to a municipality or
county for an improvement project undertaken by a public improvement district under
Chapter 372, Local Government Code. The assessment may be due annually or in
periodic installments. More information concerning the amount of the assessment and the
due dates of that assessment may be obtained from the municipality or county levying
the assessment. The amount of the assessments is subject to change. Your failure to pay
the assessments could result in a lien on and the foreclosure of your property.
(8) TRANSFER FEES: If the Property is subject to a private transfer fee obligation, §5.205,
Property Code, requires Seller to notify Buyer as follows: The private transfer fee
obligation may be governed by Chapter 5, Subchapter G of the Texas Property Code.
(9) PROPANE GAS SYSTEM SERVICE AREA: If the Property is located in a propane gas
system service area owned by a distribution system retailer, Seller must give Buyer
written notice as required by §141.010, Texas Utilities Code. An addendum containing
the notice approved by TREC or required by the parties should be used.
7. PROPERTY CONDITION:
A. ACCESS, INSPECTIONS AND UTILITIES: Seller shall permit Buyer and Buyer’s agents access
to the Property at reasonable times. Buyer may have the Property inspected by inspectors
selected by Buyer and licensed by TREC or otherwise permitted by law to make inspections.
Seller at Seller's expense shall immediately cause existing utilities to be turned on and shall
keep the utilities on during the time this contract is in effect.
B. SELLER'S DISCLOSURE NOTICE PURSUANT TO §5.008, TEXAS PROPERTY CODE (Notice):
(Check one box only)
 (1) Buyer has received the Notice.
 (2) Buyer has not received the Notice. Within
days after the effective date of this
contract, Seller shall deliver the Notice to Buyer. If Buyer does not receive the Notice,
Buyer may terminate this contract at any time prior to the closing and the earnest money
will be refunded to Buyer. If Seller delivers the Notice, Buyer may terminate this contract
for any reason within 7 days after Buyer receives the Notice or prior to the closing,
whichever first occurs, and the earnest money will be refunded to Buyer.
 (3)The Seller is not required to furnish the notice under the Texas Property Code.
C. SELLER’S DISCLOSURE OF LEAD-BASED PAINT AND LEAD-BASED PAINT HAZARDS is
required by Federal law for a residential dwelling constructed prior to 1978.
D. ACCEPTANCE OF PROPERTY CONDITION: “As Is” means the present condition of the Property
with any and all defects and without warranty except for the warranties of title and the
warranties in this contract. Buyer’s agreement to accept the Property As Is under Paragraph
7D(1) or (2) does not preclude Buyer from inspecting the Property under Paragraph 7A, from
negotiating repairs or treatments in a subsequent amendment, or from terminating this
contract during the Option Period, if any.
(Check one box only)
 (1) Buyer accepts the Property As Is.
 (2) Buyer accepts the Property As Is provided Seller, at Seller’s expense, shall complete the
following specific repairs and treatments:
.
(Do not insert general phrases, such as “subject to inspections” that do not identify
specific repairs and treatments.)
E. LENDER REQUIRED REPAIRS AND TREATMENTS: Unless otherwise agreed in writing, neither
party is obligated to pay for lender required repairs, which includes treatment for wood
destroying insects. If the parties do not agree to pay for the lender required repairs or
treatments, this contract will terminate and the earnest money will be refunded to Buyer. If
the cost of lender required repairs and treatments exceeds 5% of the Sales Price, Buyer may
terminate this contract and the earnest money will be refunded to Buyer.
F. COMPLETION OF REPAIRS AND TREATMENTS: Unless otherwise agreed in writing: (i) Seller
shall complete all agreed repairs and treatments prior to the Closing Date; and (ii) all required
permits must be obtained, and repairs and treatments must be performed by persons who are
licensed to provide such repairs or treatments or, if no license is required by law, are
commercially engaged in the trade of providing such repairs or treatments. At Buyer’s
election, any transferable warranties received by Seller with respect to the repairs and
treatments will be transferred to Buyer at Buyer’s expense. If Seller fails to complete any
agreed repairs and treatments prior to the Closing Date, Buyer may exercise remedies under
Paragraph 15 or extend the Closing Date up to 5 days if necessary for Seller to complete the
repairs and treatments.
G. ENVIRONMENTAL MATTERS: Buyer is advised that the presence of wetlands, toxic substances,
including asbestos and wastes or other environmental hazards, or the presence of a
threatened or endangered species or its habitat may affect Buyer’s intended use of the
Initialed for identification by Buyer
and Seller
TREC NO. 20-12
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Unit 5 The Sales Contract
89
FIGURE 5.1: One to Four Family Residential Contract (Resale) (continued)
Contract Concerning
(Address of Property)
Page 5 of 9
4-28-2014
Property. If Buyer is concerned about these matters, an addendum promulgated by TREC or
required by the parties should be used.
H. RESIDENTIAL SERVICE CONTRACTS: Buyer may purchase a residential service contract
from a residential service company licensed by TREC. If Buyer purchases a residential
service contract, Seller shall reimburse Buyer at closing for the cost of the residential
service contract in an amount not exceeding $
. Buyer should review any
residential service contract for the scope of coverage, exclusions and limitations. The
purchase of a residential service contract is optional. Similar coverage may be
purchased from various companies authorized to do business in Texas.
8. BROKERS' FEES: All obligations of the parties for payment of brokers’ fees are contained in
separate written agreements.
9. CLOSING:
A. The closing of the sale will be on or before
, 20
, or within 7
days after objections made under Paragraph 6D have been cured or waived, whichever date
is later (Closing Date). If either party fails to close the sale by the Closing Date, the nondefaulting party may exercise the remedies contained in Paragraph 15.
B. At closing:
(1) Seller shall execute and deliver a general warranty deed conveying title to the Property
to Buyer and showing no additional exceptions to those permitted in Paragraph 6 and
furnish tax statements or certificates showing no delinquent taxes on the Property.
(2) Buyer shall pay the Sales Price in good funds acceptable to the escrow agent.
(3) Seller and Buyer shall execute and deliver any notices, statements, certificates,
affidavits, releases, loan documents and other documents reasonably required for the
closing of the sale and the issuance of the Title Policy.
(4) There will be no liens, assessments, or security interests against the Property which will
not be satisfied out of the sales proceeds unless securing the payment of any loans
assumed by Buyer and assumed loans will not be in default.
(5)If the Property is subject to a residential lease, Seller shall transfer security deposits (as
defined under §92.102, Property Code), if any, to Buyer. In such an event, Buyer shall
deliver to the tenant a signed statement acknowledging that the Buyer has received the
security deposit and is responsible for the return of the security deposit, and specifying
the exact dollar amount of the security deposit.
10.POSSESSION:
A Buyer’s Possession: Seller shall deliver to Buyer possession of the Property in its present or
required condition, ordinary wear and tear excepted: upon closing and funding
according to a temporary residential lease form promulgated by TREC or other written
lease required by the parties. Any possession by Buyer prior to closing or by Seller after
closing which is not authorized by a written lease will establish a tenancy at sufferance
relationship between the parties. Consult your insurance agent prior to change of
ownership and possession because insurance coverage may be limited or
terminated. The absence of a written lease or appropriate insurance coverage may
expose the parties to economic loss.
B. Leases:
(1)After the Effective Date, Seller may not execute any lease (including but not limited to
mineral leases) or convey any interest in the Property without Buyer’s written consent.
(2) If the Property is subject to any lease to which Seller is a party, Seller shall deliver to
Buyer copies of the lease(s) and any move-in condition form signed by the tenant
within 7 days after the Effective Date of the contract.
11. SPECIAL PROVISIONS: (Insert only factual statements and business details applicable to
the sale. TREC rules prohibit licensees from adding factual statements or business details for
which a contract addendum, lease or other form has been promulgated by TREC for mandatory
use.)
12. SETTLEMENT AND OTHER EXPENSES:
A. The following expenses must be paid at or prior to closing:
(1) Expenses payable by Seller (Seller's Expenses):
(a) Releases of existing liens, including prepayment penalties and recording fees;
release of Seller’s loan liability; tax statements or certificates; preparation of deed;
one-half of escrow fee; and other expenses payable by Seller under this contract.
(b) Seller shall also pay an amount not to exceed $
to be applied in the
Initialed for identification by Buyer
and Seller
TREC NO. 20-12
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FIGURE 5.1: One to Four Family Residential Contract (Resale) (continued)
Contract Concerning
13.
14.
15.
16.
17.
(Address of Property)
Page 6 of 9
4-28-2014
following order: Buyer’s Expenses which Buyer is prohibited from paying by FHA,
VA, Texas Veterans Land Board or other governmental loan programs, and then to
other Buyer’s Expenses as allowed by the lender.
(2) Expenses payable by Buyer (Buyer's Expenses): Appraisal fees; loan application fees;
adjusted origination charges; credit reports; preparation of loan documents; interest
on the notes from date of disbursement to one month prior to dates of first monthly
payments; recording fees; copies of easements and restrictions; loan title policy with
endorsements required by lender; loan-related inspection fees; photos; amortization
schedules; one-half of escrow fee; all prepaid items, including required premiums for
flood and hazard insurance, reserve deposits for insurance, ad valorem taxes and
special governmental assessments; final compliance inspection; courier fee; repair
inspection; underwriting fee; wire transfer fee; expenses incident to any loan; Private
Mortgage Insurance Premium (PMI), VA Loan Funding Fee, or FHA Mortgage Insurance
Premium (MIP) as required by the lender; and other expenses payable by Buyer under
this contract.
B. If any expense exceeds an amount expressly stated in this contract for such expense to
be paid by a party, that party may terminate this contract unless the other party agrees to
pay such excess. Buyer may not pay charges and fees expressly prohibited by FHA, VA,
Texas Veterans Land Board or other governmental loan program regulations.
PRORATIONS: Taxes for the current year, interest, maintenance fees, assessments, dues
and rents will be prorated through the Closing Date. The tax proration may be calculated
taking into consideration any change in exemptions that will affect the current year's taxes.
If taxes for the current year vary from the amount prorated at closing, the parties shall
adjust the prorations when tax statements for the current year are available. If taxes are not
paid at or prior to closing, Buyer shall pay taxes for the current year.
CASUALTY LOSS: If any part of the Property is damaged or destroyed by fire or other
casualty after the effective date of this contract, Seller shall restore the Property to its
previous condition as soon as reasonably possible, but in any event by the Closing Date. If
Seller fails to do so due to factors beyond Seller’s control, Buyer may (a) terminate this
contract and the earnest money will be refunded to Buyer (b) extend the time for
performance up to 15 days and the Closing Date will be extended as necessary or (c) accept
the Property in its damaged condition with an assignment of insurance proceeds and receive
credit from Seller at closing in the amount of the deductible under the insurance policy.
Seller’s obligations under this paragraph are independent of any other obligations of Seller
under this contract.
DEFAULT: If Buyer fails to comply with this contract, Buyer will be in default, and Seller may
(a) enforce specific performance, seek such other relief as may be provided by law, or both,
or (b) terminate this contract and receive the earnest money as liquidated damages, thereby
releasing both parties from this contract. If Seller fails to comply with this contract, Seller will
be in default and Buyer may (a) enforce specific performance, seek such other relief as may
be provided by law, or both, or (b) terminate this contract and receive the earnest money,
thereby releasing both parties from this contract.
MEDIATION: It is the policy of the State of Texas to encourage resolution of disputes
through alternative dispute resolution procedures such as mediation. Any dispute between
Seller and Buyer related to this contract which is not resolved through informal discussion
will be submitted to a mutually acceptable mediation service or provider. The parties to the
mediation shall bear the mediation costs equally. This paragraph does not preclude a party
from seeking equitable relief from a court of competent jurisdiction.
ATTORNEY'S FEES: A Buyer, Seller, Listing Broker, Other Broker, or escrow agent who
prevails in any legal proceeding related to this contract is entitled to recover reasonable
attorney’s fees and all costs of such proceeding.
18. ESCROW:
A. ESCROW: The escrow agent is not (i) a party to this contract and does not have liability
for the performance or nonperformance of any party to this contract, (ii) liable for interest
on the earnest money and (iii) liable for the loss of any earnest money caused by the
failure of any financial institution in which the earnest money has been deposited unless
the financial institution is acting as escrow agent.
B. EXPENSES: At closing, the earnest money must be applied first to any cash down
payment, then to Buyer's Expenses and any excess refunded to Buyer. If no closing
occurs, escrow agent may: (i) require a written release of liability of the escrow agent
from all parties, (ii) require payment of unpaid expenses incurred on behalf of a party,
and (iii) only deduct from the earnest money the amount of unpaid expenses incurred on
behalf of the party receiving the earnest money.
C. DEMAND: Upon termination of this contract, either party or the escrow agent may send
a release of earnest money to each party and the parties shall execute counterparts of
Initialed for identification by Buyer
and Seller
TREC NO. 20-12
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Unit 5 The Sales Contract
FIGURE 5.1: One to Four Family Residential Contract (Resale) (continued)
Contract Concerning
Page 7 of 9
(Address of Property)
4-28-2014
the release and deliver same to the escrow agent. If either party fails to execute the
release, either party may make a written demand to the escrow agent for the earnest
money. If only one party makes written demand for the earnest money, escrow agent shall
promptly provide a copy of the demand to the other party. If escrow agent does not
receive written objection to the demand from the other party within 15 days, escrow agent
may disburse the earnest money to the party making demand reduced by the amount of
unpaid expenses incurred on behalf of the party receiving the earnest money and escrow
agent may pay the same to the creditors. If escrow agent complies with the provisions of
this paragraph, each party hereby releases escrow agent from all adverse claims related to
the disbursal of the earnest money.
D. DAMAGES: Any party who wrongfully fails or refuses to sign a release acceptable to the
escrow agent within 7 days of receipt of the request will be liable to the other party for
liquidated damages in an amount equal to the sum of: (i) three times the amount of the
earnest money; (ii) the earnest money; (iii) reasonable attorney's fees; and (iv) all costs of
suit.
E. NOTICES: Escrow agent's notices will be effective when sent in compliance with Paragraph
21. Notice of objection to the demand will be deemed effective upon receipt by escrow
agent.
19. REPRESENTATIONS: All covenants, representations and warranties in this contract survive
closing. If any representation of Seller in this contract is untrue on the Closing Date, Seller
will be in default. Unless expressly prohibited by written agreement, Seller may continue to
show the Property and receive, negotiate and accept back up offers.
20. FEDERAL TAX REQUIREMENTS: If Seller is a "foreign person,” as defined by applicable
law, or if Seller fails to deliver an affidavit to Buyer that Seller is not a "foreign person,” then
Buyer shall withhold from the sales proceeds an amount sufficient to comply with applicable
tax law and deliver the same to the Internal Revenue Service together with appropriate tax
forms. Internal Revenue Service regulations require filing written reports if currency in
excess of specified amounts is received in the transaction.
21. NOTICES: All notices from one party to the other must be in writing and are effective when
mailed to, hand-delivered at, or transmitted by facsimile or electronic transmission as
follows:
To Seller at:
To Buyer at:
Telephone:
(
)
Telephone:
(
)
Facsimile:
(
)
Facsimile:
(
)
E-mail:
E-mail:
22. AGREEMENT OF PARTIES: This contract contains the entire agreement of the parties and
cannot be changed except by their written agreement. Addenda which are a part of this
contract are (Check all applicable boxes):
 Third Party Financing Addendum for Credit
 Environmental Assessment, Threatened or
Endangered Species and Wetlands
Approval
Addendum
 Seller Financing Addendum
 Seller’s Temporary Residential Lease
 Addendum for Property Subject to
 Short Sale Addendum
Mandatory Membership in a Property
Owners Association
 Addendum for Property Located Seaward
 Buyer’s Temporary Residential Lease
of the Gulf Intracoastal Waterway


Loan Assumption Addendum

Addendum for Seller's Disclosure of
Information on Lead-based Paint and Leadbased Paint Hazards as Required by
Federal Law

Addendum for Reservation of Oil, Gas
and Other Minerals

Addendum for Property in a Propane Gas
System Service Area


Addendum for "Back-Up" Contract

Other (list):
Addendum for Sale of Other Property by
Buyer
Addendum for Coastal Area Property
Initialed for identification by Buyer
and Seller
TREC NO. 20-12
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FIGURE 5.1: One to Four Family Residential Contract (Resale) (continued)
Contract Concerning
Page 8 of 9
(Address of Property)
4-28-2014
23. TERMINATION OPTION: For nominal consideration, the receipt of which is hereby
acknowledged by Seller, and Buyer's agreement to pay Seller $
(Option Fee)
within 3 days after the effective date of this contract, Seller grants Buyer the unrestricted right to
terminate this contract by giving notice of termination to Seller within
days after the
effective date of this contract (Option Period). If no dollar amount is stated as the Option Fee or
if Buyer fails to pay the Option Fee to Seller within the time prescribed, this paragraph will not be
a part of this contract and Buyer shall not have the unrestricted right to terminate this contract.
If Buyer gives notice of termination within the time prescribed, the Option Fee will not be
refunded; however, any earnest money will be refunded to Buyer. The Option Fee will will
not be credited to the Sales Price at closing. Time is of the essence for this paragraph and
strict compliance with the time for performance is required.
24. CONSULT AN ATTORNEY BEFORE SIGNING: TREC rules prohibit real estate licensees from
giving legal advice. READ THIS CONTRACT CAREFULLY.
Buyer's
Attorney is:
Seller's
Attorney is:
Telephone: (
)
Telephone: (
)
(
)
Facsimile:
(
)
Facsimile:
E-mail:
E-mail:
EXECUTED the
day of
, 20
(BROKER: FILL IN THE DATE OF FINAL ACCEPTANCE.)
Buyer
Seller
Buyer
Seller
(EFFECTIVE DATE).
The form of this contract has been approved by the Texas Real Estate Commission. TREC forms are intended for use only by tr ained real estate
licensees. No representation is made as to the legal validity or adequacy of any provision in any specific transactions. It is not intended for
complex transactions. Texas Real Estate Commission, P.O. Box 12188, Austin, TX 78711-2188, (512) 936-3000 (http://www.trec.texas.gov)
TREC NO. 20-12. This form replaces TREC NO. 20-11.
Initialed for identification by Buyer
and Seller
TREC NO. 20-12
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Unit 5 The Sales Contract
93
FIGURE 5.1: One to Four Family Residential Contract (Resale) (continued)
Contract Concerning
Page 9 of 9
(Address of Property)
4-28-2014
BROKER INFORMATION
(Print name(s) only. Do not sign)
Other Broker Firm
represents
License No.
 Buyer only as Buyer’s agent
 Seller as Listing Broker’s subagent
Listing Broker Firm
represents
License No.
 Seller and Buyer as an intermediary
 Seller only as Seller’s agent
Name of Associate’s Licensed Supervisor
Telephone
Name of Associate’s Licensed Supervisor
Telephone
Associate’s Name
Telephone
Listing Associate’s Name
Telephone
Listing Broker’s Office Address
Facsimile
Other Broker's Address
Facsimile
City
State
Zip
Associate’s Email Address
City
State
Zip
Listing Associate’s Email Address
Selling Associate’s Name
Telephone
Name of Selling Associate’s Licensed Supervisor
Telephone
Selling Associate’s Office Address
Facsimile
City
State
Zip
Selling Associate’s Email Address
Listing Broker has agreed to pay Other Broker
of the total sales price when the Listing Broker’s
fee is received. Escrow agent is authorized and directed to pay other Broker from Listing Broker’s fee at closing.
OPTION FEE RECEIPT
Receipt of $
(Option Fee) in the form of
Seller or Listing Broker
is acknowledged.
Date
CONTRACT AND EARNEST MONEY RECEIPT
Receipt of Contract and
is acknowledged.
$
Earnest Money in the form of
Escrow Agent:
Date:
By:
Email Address
Telephone (
Address
City
State
Initialed for identification by Buyer
Zip
and Seller
Facsimile: (
)
)
TREC NO. 20-12
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All offers should be in writing and presented to the property owner as quickly as is
reasonably practical. The TREC Rules call for immediate presentation. Occasionally, a buyer’s agent may make a verbal offer to a listing agent. In these situations,
the agent should try to find out if the buyer will put the offer in writing. If not,
the agent must submit the verbal offer to the seller. The seller then can make an
election as to what to do. The choices are to
■■ accept subject to the written contract containing all acceptable terms and
conditions,
■■ counter the offer subject to the written contract containing all acceptable
terms and conditions, or
■■ reject the offer.
A seller hires a real estate professional to be the greatest marketing person to get
the highest possible price, which means screening in offers rather than screening
out potentially good offers. While this approach happens most often in commercial deals, it can also be used in residential transactions. Remember, the statute of
frauds only applies to the enforcement of the contract, and not the negotiation
for the contract.
No real estate broker or salesperson has the right to withhold an offer from a property owner. To do so may result in suspension or revocation of one’s license under
the provisions of the Texas Real Estate License Act (TRELA) or, worse, result
in an unpleasant lawsuit for tortious interference. A tort is an act that damages
another individual and gives rise to legal action. A property owner may consider
the licensee’s failure to present an offer in a timely manner a tortious interference
with the owner’s ability to sell the property. Unless instructed otherwise by the
owner, all offers must be presented. A seller’s instruction not to present backup
offers must be given to the licensee in writing.
Upon receipt of an offer, the seller can accept, reject, or make a counteroffer. The
contract must be signed and in most cases, initialed on each page. The initialing
of each page is to ensure that no one makes a change to the contract after signatures are obtained. If the offer is acceptable to the seller, the offer is signed and
dated and returned to the buyer. It is now a contract of sale. If the offer is rejected,
the offer is returned to the buyer marked “void.”
Any change made to the original offer should be marked with a cross-hatch, leaving a space for the seller to initial and also for the buyer to initial if willing to
accept the change. No blanks should ever be left in the contract document due to
the risk that someone might insert something later that was not actually agreed
upon by the buyer and the seller. A blank may be filled with “NA”—meaning
not applicable—or a drawn line. If an entire paragraph is not applicable in a particular situation, a line may be drawn vertically through the paragraph or marked
out line-by-line, and initialed in the margin. See Figure 5.2 for an illustration of
cross-hatching.
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Unit 5 The Sales Contract
95
FIGURE 5.2: Change Made to a Contract
A counteroffer is a new offer;
it rejects the original offer.
Counteroffer Any change by the seller to the terms proposed by the buyer
creates a counteroffer. The original offer ceases to exist because the seller has
rejected it. The counteroffer is basically a new offer. The buyer may accept or
reject the seller’s counteroffer. If the buyer is willing to accept the changes made
in the counteroffer, the buyer should initial at the crosshatch next to each change.
Once the seller has been notified of the buyer’s acceptance, the offer to purchase
becomes a ratified contract. If the buyer is not willing to accept the changes made
by the seller, the buyer should cross out the change and the crosshatch containing the seller’s initials. The buyer may now make a different change marking with
a crosshatch and buyer’s initials. This new offer is then returned to the seller for
acceptance, rejection, or an additional counteroffer.
The process may continue by making additional counteroffers. Any change in the
last offer may result in a counteroffer until either the parties reach agreement or
one party walks away.
An offer or counteroffer may be withdrawn at any time before it has been accepted.
This is often a point of confusion when either buyer or seller has made a counteroffer that has not been accepted and the offering party wishes to withdraw the
counter.
P R A C T I C E A seller has listed his home for $250,000 and is not willing to
convey the washer and dryer.
I N
1. Offer: Buyer makes an offer of $200,000 and wants the washer and dryer
included.
2. Counteroffer: Seller changes price to $230,000 and agrees to convey the
washer and dryer.
3. Counteroffer: Buyer changes price to $215,000 but still wants the washer and
dryer.
Seller makes no response for five days and buyer’s agent notifies seller’s agent that
the offer is withdrawn. Seller now wants to accept the $215,000 offer, but it is too late.
Acceptance If the seller agrees to the original offer or a later counteroffer exactly as it is made and signs and initials the document, the offer has been
accepted and a contract is formed. The seller’s agent must advise the buyer’s agent
of the seller’s acceptance. Some contracts may call for an attorney’s approval
before final acceptance.
An offer is not considered accepted until the person making the offer has been
notified of the other party’s acceptance. When the parties communicate through
an agent or at a distance, questions may arise regarding whether an acceptance,
rejection, or counteroffer has occurred. Though current technology allows for
fast communication, a signed agreement that is faxed, for example, would not
necessarily constitute adequate communication unless this is so specified in the
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contract. The agents should transmit all offers, acceptances, or other responses as
soon as possible to avoid any questions of proper communication.
A copy of the signed contract must be provided to each party. In some states, a
contract is not considered to be fully in force until a final signed copy is physically
delivered to both parties.
Statute of Frauds
The statute of frauds states that certain contracts must be reduced to writing and
signed by the party charged with the promise to enforce. These include
■■ contracts for the sale of real estate,
■■ a lease for real estate for longer than one year,
■■ any agreement for which performance time is greater than one year (options,
first right of refusal, etc.), and
■■ commission agreements (listing or buyer representation, oil and gas leases).
If there is a conflict between the written contract and parole evidence, the courts
have ruled that the written words will be controlling. Therefore, the agent must
take great care not to make nor allow customers/clients to make any verbal promises to avoid any conflict in the future. This is one of the primary reasons that
agents will keep sellers and buyers from meeting until after the closing.
The deed is the final agreement between the parties, which means that all unfulfilled promises that are not merged into the deed don’t have to be kept. The one
major exception to this rule is fraud. If a seller made promises to a buyer that the
seller did not intend to keep in order to get the buyer to sign the contract, then
the contract might be considered fraudulent inducement. In the case of fraud, a
court may consider parole evidence to demonstrate the presence of fraud in the
deal.
The One to Four Family Residential Contract (Resale) specifies certain accessories in paragraph 2C, which will be conveyed, with an opportunity to exclude in
paragraph 2D those items the seller wishes to keep.
I N P R A C T I C E The agent must take the time to thoroughly explain this section of the contract. The following items are often the source of conflict between sellers
and buyers:
■■
Window coverings and curtain rods
■■
Unattached fireplace screens
■■
Above-ground pools and hot tubs
■■
Chandeliers
If a seller does not intend for an item to go with the house, then it should be removed
prior to showings.
Letter of Intent
In many states, specific guidelines have been drawn, either by agreement between
broker and lawyer associations, by court decision, or by statute, regarding the
authority of real estate licensees to prepare documents for their clients and customers. As a rule, a real estate broker is not authorized to practice law, which can
be construed to be the preparation of legal documents. Only a licensed attorney
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Unit 5 The Sales Contract
can prepare legal documents and give legal advice. However, a broker or salesperson acting on the behalf of the broker may be permitted to fill in the blanks of
preprinted documents (such as sales contracts and leases).
In some states (not Texas), licensees may prepare a shorter document called a letter of intent (LOI), instead of a complete sales contract. The binder states the
essential terms of the offer. A more formal and complete contract of sale is drawn
up once the seller accepts and signs the LOI. A LOI might also be used when the
details of the transaction are too complex for the standard sales contract form.
This is often the case with commercial transactions.
Equitable Title
When a buyer signs a contract to purchase real estate, the buyer does not receive
title to the land. Title transfers only upon delivery and acceptance of a deed. However, after both buyer and seller have executed a sales contract, the buyer acquires
an interest in the land. This interest is called equitable title. A person who holds
equitable title has rights that vary from state to state.
In some states, equitable title may give the buyer an insurable interest in the property. In other cases, equitable title may give the buyer the right to legally require
that the seller transfer the property to the buyer. If the parties decide to not go
through with the purchase and sale, the buyer may be required to give the seller a
quitclaim deed to release the buyer’s equitable interest in the land. The developer
of a mall shopping center might begin to initiate rental agreements with anchor
stores for the project based on the developer’s equitable interest in purchasing
the land. Any such agreement should be made contingent on settlement of the
property.
THE DOCUMENT
All real estate sales contracts can be divided into a number of separate parts.
Although each form of contract contains these divisions, their location within
a particular contract may vary depending on who has prepared the document.
In addition to the sales price and terms being offered, sales contracts typically
include information as described below.
Personal Information
Personal information for both the purchaser and the seller may include
■■ the purchaser’s name and a statement of the purchaser’s obligation to pur-
chase the property, including how the purchaser intends to take title;
■■ the seller’s name and a statement of the type of deed a seller agrees to give,
■■
■■
■■
■■
including any covenants, conditions, and restrictions;
a listing of any personal property that is to be left on the premises (e.g.,
appliances, lawn and garden equipment, window treatments);
specific items that are to be removed by the seller (e.g., storage shed, firewood, trash);
the transfer of any applicable warranties on heating and cooling systems or
built-in appliances;
the identification of any leased equipment to be transferred to the new
owner (e.g., security system, cable service, water softener system);
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■■ the purchaser’s right to inspect the property shortly before the closing
to ensure that all contract provisions have been met (usually called a
walk-through);
■■ the method by which real estate taxes, rents, fuel costs, and any other
expenses are to be prorated; and
■■ the transfer of payment for any special assessments.
Legal Description
A street address, while usually enough to find the location of a particular building, is not precise enough to describe legal ownership. Addresses change as streets
are renamed, or rural roads might become public streets in growing communities.
Sales contracts, deeds, and mortgages require a more specific description of property to be binding.
A legal description is a detailed way of describing a parcel of land. The description is based on information collected through a survey—the process by which
boundaries are measured by calculating the dimensions and area to determine the
exact location of a piece of land. Courts have stated that a description is legally
sufficient if it allows a surveyor to locate the parcel. In this context, the term
locate means that the surveyor must be able to define the exact boundaries of
the property. A street address will not tell a surveyor how large the property is or
where it begins and ends. Several alternative systems of identification have been
developed to express a legal description of real estate. Although each method can
be used independently, the methods may be combined in some situations. Some
states use only one method; others use all three.
Metes-and-Bounds Method
Metes-and-bounds descriptions were used in the original 13 colonies and in
those states that were being settled while the rectangular survey system was being
developed. “Metes” means to measure, and “bounds” means linear directions. The
method relies on a property’s physical features to determine the boundaries and
measurements of the parcel. A metes-and-bounds description starts at a designated place on the parcel, called the point of beginning (POB). The POB is
also the point of ending (POE), but often only the POB is used in describing the
property. From there, the surveyor proceeds around the property’s boundaries. The
boundaries are recorded by referring to linear measurements, natural and artificial landmarks (called monuments), and directions. A metes-and-bounds description always ends back at the POB so that the tract being described is completely
enclosed.
Monuments are fixed objects used to identify the POB, all corners of the parcel
or ends of boundary segments, and the location of intersecting boundaries. In
colonial times, a monument might have been a natural object such as a stone, a
large tree, a lake, or a stream. It also might have been a street, a fence, or other
marker. Today, monuments are iron pins or concrete posts placed by the U.S.
Corps of Engineers, other government departments, or trained private surveyors.
Measurements often include the words “more or less” because the location of the
monuments is more important than the distances between them. Because monuments can be moved, surveyors give their final metes-and-bounds reference in
terms of cardinal points and distance. They include the statement “to the point of
beginning (POB)” to ensure closure and to remove questions if an error in footage
prevents closure.
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Unit 5 The Sales Contract
99
An example of a historical metes-and-bounds description of a parcel of land (see
Figure 5.3) follows:
A tract of land located in Red Skull, Boone County, Virginia, described
as follows: Beginning at the intersection of the east line of Jones Road and
the south line of Skull Drive; then east along the south line of Skull Drive
200 feet; then south 15° east 216.5 feet, more or less, to the center thread
of Red Skull Creek then northwesterly along the center line of said creek to
its intersection with the east line of Jones Road; then north 105 feet, more
or less, along the east line of Jones Road to the point of beginning.
FIGURE 5.3: Metes-and-Bounds Tract
Point of
Beginning
Jones Rd.
Skull Dr.
200'
N
The directions of township
lines and range lines may
be easily remembered by
thinking of the words this way:
Township lines
Range lines
105'
216.5'
Red Sk
u
ll Creek
Rectangular Survey System The rectangular survey system, sometimes
called the government survey system, was established by Congress in 1785 to
standardize the description of land acquired by the newly formed federal government. By dividing the land into rectangles, the survey provided land descriptions
by describing the rectangle(s) in which the land was located. The system is based
on two sets of intersecting lines: principal meridians and base lines. The principal
meridians run north and south, and the base lines run east and west. Both are
located by reference to degrees of longitude and latitude. Each principal meridian
has a name or number and is crossed by a base line. Each principal meridian and
its corresponding base line are used to survey a definite area of land, indicated on
the map by boundary lines. There are 37 principal meridians in the United States.
The land on either side of a principal meridian is divided into six-mile-wide strips
by lines that run north and south, parallel to the meridian. These north-south
strips of land are called ranges (see Figure 5.4). They are designated by consecutive numbers east or west of the principal meridian. For example, Range 3 East
would be a strip of land between 12 and 18 miles east of its principal meridian.
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N
Principal Meridian
FIGURE 5.4: Range Lines
Base Line
Range Lines
Memory Tip
Township Numbering
Townships are numbered the
same way a field is plowed.
Remember: right to left, left to
right, right to left.
Lines running east and west, parallel to the base line and six miles apart, are called
township lines (see Figure 5.5). They form strips of land called township tiers.
These township tiers are designated by consecutive numbers north or south of the
base line. For example, the strip of land between 6 and 12 miles north of a base
line is Township 2 North.
Principal Meridian
FIGURE 5.5: Township Lines
N
Township Lines
Base Line
When the horizontal township lines and the vertical range lines intersect, they
form squares. These township squares are the basic units of the rectangular survey
system (see Figure 5.6). Townships are 6 miles square and contain 36 square miles
(23,040 acres).
N
Principal Meridian
FIGURE 5.6: Townships in the Rectangular Survey System
Township Lines
Base Line
Range Lines
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Unit 5 The Sales Contract
101
Each township is given a legal description. The township’s description includes
the following:
■■ Designation of the township tier in which the township is located
■■ Designation of the range strip
■■ Name or number of the principal meridian for that area
In Figure 5.6, the shaded township is described as Township 3 North, Range 4 East of the principal meridian. This township is the third strip, or
tier, north of the base line, and it designates the township number and direction. The
township is also located in the fourth range strip (those running north and south) east
of the principal meridian. Finally, reference is made to the principal meridian because
the land being described is within the boundary of land surveyed from that meridian.
This description is abbreviated as T3N, R4E 4th Principal Meridian.
F O R
E X A M P L E
Sections Township squares are subdivided into sections and subsections called
halves and quarters, which can be further divided. Each township contains 36
sections. Each section is one square mile or 640 acres, with 43,560 square feet in
each acre. Sections are numbered 1 through 36, as shown in Figure 5.7. Section 1
is always in the northeast, or upper right-hand, corner. The numbering proceeds
right to left to the upper left-hand corner. From there, the numbers drop down to
the next tier and continue from left to right, then back from right to left. By law,
each Section 16 was set aside for school purposes, and the sale or rental proceeds
from this land were originally available for township school use. The schoolhouse
was usually located in this section so it would be centrally located for all the
students in the township. As a result, Section 16 is commonly called a school
section.
FIGURE 5.7: Sections in a Township
N
W
6
5
4
3
2
1
7
8
9
10 11 12
18 17 16 15 14 13
19 20 21 22 23 24
E
30 29 28 27 26 25
31 32 33 34 35 36
S
Math Shortcut
To calculate acres in a survey
system description, multiply
all the denominators and
divide that number into 640
acres. For example, the SE¼
of SE¼ of SE¼ of Section 1
= 4 × 4 × 4 = 64; 640 ÷ 64 =
10 acres.
Sections are divided into halves (320 acres) and quarters (160 acres). In turn,
each of those parts is further divided into halves and quarters. The southeast quarter of a section, which is a 160-acre tract, is abbreviated SE¼. The SE¼ of SE¼
of SE¼ of Section 1 would be a 10-acre square in the lower right-hand corner of
Section 1 (see Figure 5.8).
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FIGURE 5.8: A Section
5,280 Feet
1,320
2,640
1,320
W1/2
of NW1/4
(80 Acres)
NW1/4
of SW1/4
(40 Acres)
1,320
2,640
E1/2
of NW1/4
(80 Acres)
NE1/4
of SW1/4
(40 Acres)
NE1/4
(160 Acres)
N1/2 of NW1/4
of SE1/4
(20 Acres)
W1/2 of
NE1/4
of SE1/4
(20 Acres)
20 Acres
20 Acres
1,320
5 Acres
SW1/4
of SW1/4
(40 Acres)
40 Acres
440 Yards
(10 Acres) (10 Acres) 5 Acres
660
Feet
660
Feet
5
5
Acs. Acs.
SE1/4 of
SE1/4 of
SE1/4
10 Acres
Legal descriptions should always include the name of the county and state in
which the land is located because meridians often relate to more than one state
and occasionally relate to two base lines. For example, the description “the southwest quarter of Section 10, Township 4 North, Range 1 West of the Fourth Principal Meridian” could refer to land in either Illinois or Wisconsin.
Metes-and-Bounds Descriptions Within the Rectangular Survey System Within
the Rectangular Survey System Land in states that use the rectangular survey system may also require a metes-and-bounds description. This usually occurs in one
of three situations: (1) when describing an irregular tract, (2) when a tract is too
small to be described by quarter-sections, or (3) when a tract does not follow the
lot or block lines of a recorded subdivision or section, quarter-section lines, or
other fractional section lines.
Lot-and-Block System The third method of legal description is the lot-andblock (recorded plat) system. This system uses lot and block numbers referred to
in a plat map filed in the public records of the county where the land is located.
The plat map is a map of a town, a section, or a subdivision, indicating the location and boundaries of individual properties. The lot-and-block system is used
mostly in subdivisions and urban areas.
A lot-and-block survey is performed in two steps. First, a large parcel of land is
described either by the metes-and-bounds method or by rectangular survey. Once
this large parcel is surveyed, it is broken into smaller parcels. For each parcel
described under the lot-and-block system, the “lot” refers to the numerical designation of any particular parcel. The “block” refers to the name of the subdivision
under which the map is recorded.
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Unit 5 The Sales Contract
The lot-and-block system starts with the preparation of a subdivision plat by a
licensed surveyor or an engineer (see Figure 5.9). On this plat, the land is divided
into numbered or lettered lots and blocks, and streets or access roads for public
use are indicated. Lot sizes and street details must be described completely and
must comply with all local ordinances and requirements. When properly signed
and approved, the subdivision plat is recorded in the county in which the land is
located. The plat becomes part of the legal description. In describing a lot from a
recorded subdivision plat, three identifiers are used:
1. Lot and block number
2. Name or number of the subdivision plat
3. Name of the county and state
FIGURE 5.9: Subdivision Plat Map of Block A
W. Line E 1/2
E 1/2 Lot 7
Well site
City of Glendale
Dkt 967-132
Fertile Acres Amended
35/38
50
70
West "F" Street
25
50
70
.0
2
25
R = 40
26.87 24.
8
9
24.08
6
N 1 10' E
85.61
7
100.53
70
N 1 10' E
100.46
80.39
8
Corner of this
subdivision
125.00
East 29.98
46.64
5
.6
63
R = 40
= 35 39'30"
12
125.37
T = 20
62
25
East - 238.00
191.36
25
1'
5
Corner of
this Subdn.
Found Bar.
70
73
N. 89 56' W. - 282.95
North Line of the South 125.17' of
Lot 7 Fertile Acres Amended
69.95
12
12
25
20
Fertile Acres Amended
35/38
T = 20
4
S 1 10'30" W - 250.66
3
R = 40
= 35 39'30"
1
25.7
.89
4
2
25.85
125.66
2
12
70
1'
N 1 10' E
85
Easement for
Public Utilities
100
1
20
East - 283.00
73
70
N 1 10' E
100
80
70
Dearing Lane
N 1 10' E
Fertile Acres Amended
35/38
125.00
25
30
30
10' Easement for
drainage
City of Glendale - Dkt 3019-108
20
Corner of this
subdivision
Corner of this
subdivision South Line of the North 230.34' of Lot 7
20
12' Easement for
Public Utilities
The following is an example of a lot-and-block description:
Lot 71, Happy Valley Estates 2, located in a portion of the southeast quarter of Section 23, Township 7 North, Range 4 East of the Seward Principal
Meridian in ____ County, ____ [state].
Some lot-and-block descriptions are not dependent on a government survey system and may simply refer to the plat recording in the land records of the county.
Lot 71, Happy Valley Estates 2, ________ County, ___________
[state].
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Caution
Legal descriptions should not be altered or combined without adequate information from a surveyor or title attorney. Legal descriptions should be copied with
extreme care. An incorrectly worded legal description in a sales contract may
result in a conveyance of more or less land than the parties intended.
For example, damages suffered from an incorrect description could be extensive
if buildings and improvements need to be moved because the land upon which
the improvements were made is not owned. Often, even punctuation is extremely
critical. Title problems can arise for the buyer who seeks to convey the property at
a future date. Even if the contract can be corrected before the sale is closed, the
licensee risks losing a commission and may be held liable for damages suffered by
an injured party because of an improperly worded legal description.
FINANCING INFORMATION
The purchase price and how the purchaser intends to pay for the property, including earnest money deposits, additional cash from the purchaser, and the conditions
of any mortgage financing, are all important elements of the financing portion of
the contract.
The amount of the down payment is stated along with a brief description of the
type of financing the purchaser is applying for. Some potential buyers might question why the seller needs to be made aware of the type of financing. The reason
is that most sales contracts are automatically contingent on the purchaser being
able to obtain financing. Because this has now been made a part of the contract,
if the purchaser is unable to obtain the stated financing, the contract may become
null and void.
I N P R A C T I C E The contract states that the purchaser will obtain a Department of Veterans Affairs (VA) zero down-payment loan. Unfortunately, it turns out that
the purchaser is not actually eligible for the VA loan and is unwilling to apply for any
other type of financing, so the contract becomes void.
Other examples of situations where the purchaser might back out of the contract
based on financial issues include the following scenarios:
■■ Purchaser applies for a 4% interest rate loan but the rate goes up to 6% and
the purchaser no longer qualifies for the loan.
■■ Purchaser’s application is rejected due to a prior bankruptcy, foreclosure, or
other credit problems.
■■ Purchaser applies for a low down payment FHA loan but is rejected and
is unwilling to apply for a conventional loan that requires a higher down
payment.
Because of the risk to the seller if the purchaser is not able to obtain the financing
described in the contract, it has become fairly common for a purchaser to provide
the seller with a written letter of lender loan approval submitted along with the
offer to purchase. This should be an actual preapproval letter, not just a prequalification. Many lenders will say someone is prequalified without doing a formal
check of credit history, employment record, and cash available for down payment
and closing costs.
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Unit 5 The Sales Contract
105
A complete discussion of financing for the purchase of real property can be found
in Unit 7.
Earnest Money Deposit
It is customary, although not mandatory, for a purchaser to provide a deposit when
making an offer to purchase real estate. This deposit, usually in the form of a
check, is called earnest money. The earnest money deposit is evidence of the
buyer’s intention to carry out the terms of the contract in good faith. The check is
given to the broker, who holds it in a special account.
The deposit amount is a matter to be agreed on by the parties. Under the terms
of most listing agreements, a real estate broker is required to accept a reasonable
amount as earnest money. As a rule, the deposit should be an amount sufficient to
■■ discourage the buyer from defaulting,
■■ compensate the seller for taking the property off the market, and
■■ cover any expenses the seller might incur if the buyer defaults.
A large earnest money deposit is usually looked on favorably by a seller, especially
when multiple offers are being made. The one with a large earnest money deposit
may be given preferential consideration.
This earnest money cannot be mixed with a broker’s personal or business funds
(called commingling). It must be retained in a special escrow account. (Exact
regulations vary according to state law.) A separate escrow account does not have
to be opened for each earnest money deposit received; all deposits may be kept
in one account. A broker must maintain full, complete, and accurate records of
all earnest money deposits. Real estate licenses may be revoked or suspended if
deposits are not managed properly.
The special escrow account may or may not pay interest, depending on state law.
If the account bears interest, some provision must be made in the contract for how
the interest earned will be distributed. Often, a check for the interest amount is
given to the buyer at closing. On the other hand, the contract may provide for the
interest to be paid to the seller as part of the purchase price.
Documenting Cash
With an all-cash contract or one with a very large down payment, it may be necessary to provide the seller with proper documentation showing that the required
funds are fully available.
DISCLOSURES
Many states have enacted mandatory disclosure laws, which help consumers make
informed decisions. Some states have instituted procedures for making disclosures
and recommended technical experts to ensure that purchasers have accurate information about the purchase of real estate. Disclosure of property conditions may
be included as part of a sales contract, or on a separate form. Many states require
separate forms for disclosing environmental problems. In addition, disclosure of
the licensee’s agency relationship is required by most states.
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CONVEYANCE OF THE PROPERTY
Specific details regarding the official conveyance of the property to the new owner
may include the following:
■■ The type of deed being provided; the purchaser may be presented with a
general warranty deed, a special warranty deed (grant deed), or a bargain and
sale deed (all will be discussed in detail in Unit 8).
■■ A specific date for the closing and transfer of possession of the property to
the purchaser
■■ The name of the escrow agent, attorney, or title company that will be
conducting the closing or settlement (the actual physical process for closing
both the loan and the conveyance of the property varies in different parts of
the country).
■■ Provision of evidence that the title has been searched and no problems
found. In cases where there is a cloud on the title, minor problems can usually be solved before settlement; more serious problems may delay the closing
or negate the entire contract.
Destruction of Premises
In many states, once the sales contract is signed by both parties, the buyer assumes
the risk of any damage to the property that may occur before closing the contract.
However, laws and court decisions in many states have placed the risk of loss on
the seller. A growing number of states have incorporated provisions of the Uniform Vendor and Purchaser Risk Act, which specifically provides that the seller
bear any loss that occurs before the title passes or the buyer takes possession.
CONTINGENCIES
Additional conditions that must be satisfied before a sales contract is fully enforceable are called contingencies. A contract may be contingent upon some action
being taken, a satisfactory inspection of some sort, attorney approval, or any other
consideration important to the purchaser. Unit 6 focuses on different types of
contingencies and how they may be implemented.
SIGNATURES
The dated signatures of all parties will be required. In some states (including
Texas), a seller’s non-owning spouse will be required to release potential marital or homestead rights. In most cases, each page of the contract will need to be
initialed.
ADDENDA AND AMENDMENTS
An amendment is a change or modification to the existing content of a contract. Any time words or provisions are added to or deleted from the body of
the contract, the contract is amended. For example, a form contract’s provision
requiring closing in 90 days might be crossed out and replaced with a 60-day
period. Amendments must be initialed or signed by all parties. If agreement is not
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Unit 5 The Sales Contract
reached, the original contract will stand. TREC promulgates an amendment for
use by licensees.
An addendum contains additional information that is part of the contract/agreement. An addendum must be signed by all parties. TREC promulgates a number
of addenda for use by licensees.
The proper use of addenda and amendments will be covered in Unit 6.
DEFAULT AND BREACH REMEDIES
For the purposes of this text, the terms default and breach will be treated the same.
They are essentially a failure to meet an obligation or perform on any promises
made in a contract. The term contract, as used here, includes any contract that is
used in the sale, leasing, and/or closing of real estate.
Remedies A non-defaulting party may have remedies available, including
■■ suit for monetary damages,
■■ rescission of the contract, and
■■ suit for specific performance.
When there is a breach, first determine the damages. If there are no damages,
there is likely no remedy which would have a monetary result. In order to claim
damages, there must be actual damages.
E X A M P L E A buyer contracts to buy a home, and, 10 days later, the
seller does not get the job transfer he thought he was getting. In the meantime, the
buyer applied for a loan, had a home inspection, and paid for an appraisal. The only
viable remedy is a rescission of the contract if the seller reimburses the out-of-pocket
expense the buyer has made and makes him whole. It is unlikely that the seller would
prevail in a specific performance suit unless the property was so unique that there
would never be an opportunity for the seller to get another offer.
F O R
E X A M P L E A buyer contracts to buy a 72-unit apartment building in a
very tight market. The buyer pays $56,000 per unit and plans to close with an Internal
Revenue Code Section 1031 tax deferred exchange, which will save him $86,000 in
taxes. Everyone agrees that the closing would take place in six months, because the
seller also wants to do a tax-deferred exchange. The seller is unable to find a property
to buy, so he wants to cancel the contract to sell. In the meantime, similar properties
are now selling for $62,000 a unit. Because of the 1031 rules, the buyer cannot now
do the tax-deferred exchange. The damages would be a combination of the increase
of price (72 × $6,000 = $432,000) plus the taxes ($86,000) = $518,000. This is a good
case for damages or specific performance.
F O R
Texas does not have an automatic liquidated damages provision (see below). The
agent may, however, suggest that the at-risk earnest money be sufficient to balance
the market risk of a home seller in the event of default. The promulgated contracts
give the majority of market risk to the seller for the time during the option period.
To balance the market, offer additional earnest money in an amount which balances the market risk.
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The amount generally considered adequate for liquidated damages is 3% of the
purchase price, or a little more if the seller moves out of the property prior to closing in anticipation of that closing.
Suit for Specific Performance If the seller breaches a real estate sales contract, the buyer may sue for specific performance unless the contract specifically
states otherwise. In a suit for specific performance, the buyer asks the court to
force the seller to go through with the sale and transfer the property as previously
agreed.
The seller tenders the deed and asks that the buyer be required to pay the agreed
price. In anticipation of a buyer planning to default on the contract, the seller is
usually advised to proceed towards settlement as scheduled in order to show good
faith intent to carry out the terms of the contract.
Curable Breach Not all breaches result in termination. This concept allows
the defaulting party to come into compliance with the contract. With the exception of the termination option (paragraph 23), the One to Four Family Residential Contract (Resale) does not have a “time is of the essence” provision, which
may allow extra time for performance.
If the buyer fails to close on the close date without an extension granted in the
contract, this is considered a curable breach and closing may take place in a reasonable time.
Anticipatory Breach The most common example of an anticipatory breach
is when the buyer decides to not proceed with the contract. The question then
becomes one of loss mitigation on the part of the seller. With this notice in mind,
the listing agent should consider returning to marketing efforts demonstrated
prior to the current contract. Most agents will mark the listing “active” in the
MLS, remove the “pending” sign, and look for a new buyer.
Substantial Compliance The following example demonstrates the concept of
substantial compliance.
E X A M P L E The contract calls for the seller to remove all the rocks in the
garden. At closing, most of the rocks were moved, but two very small rocks were still
there. One might argue that this breach would allow the buyer the remedy of rescission, but likely, substantial compliance would control.
F O R
As with all contract issues, the parties should be advised by their agents to use
common sense in the resolution of disputes. It is the agent’s responsibility to avoid
any unnecessary strain on customers/clients. Only when this fails should they be
advised to seek legal help.
Liquidated Damages To avoid a lawsuit if one party breaches the contract,
the parties may agree on a certain amount of money that will compensate the
non-breaching party. Such money is called liquidated damages. If a sales contract
specifies that the earnest money deposit is to serve as liquidated damages in case
the buyer defaults, the seller will be entitled to keep the deposit if the buyer refuses
to perform without good reason. The seller who keeps the deposit as liquidated
damages may not sue for any further damages if the contract provides that the
deposit is the seller’s sole remedy.
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Unit 5 The Sales Contract
109
The contract may limit the remedies available to the parties. A liquidated damages clause in a real estate purchase contract specifies the amount of money to
which the seller is entitled if the buyer breaches the contract.
SUMMARY
A real estate contract contains the complete agreement between a buyer and a
seller. It includes
■■ sales price and terms,
■■ legal description,
■■ evidence of title, and
■■ all terms and conditions plus any contingencies.
The process includes offer to purchase, possible counteroffers, and final acceptance.
Sales contracts must be in writing to be enforceable due to the statute of frauds.
In some states, a shorter binder is prepared before an actual contract is written.
During the time between contract acceptance and closing, the buyer has equitable
title.
The document includes
■■ sales price and terms;
■■ personal and financial information;
■■ legal description—three methods:
—— metes and bounds—older system, rotates around point of beginning,
—— rectangular survey system—uses meridian and range lines to form townships, with townships divided into sections, and
—— lot and block—based on recorded subdivision plat;
■■ earnest money deposit; and
■■ required agency or property disclosures.
Conveyance of the property involves
type of deed,
date and place of closing,
name of closing agent,
results of title search,
possible destruction of premises,
contingencies to be satisfied,
signatures of all parties, and
addenda or amendments.
■■
■■
■■
■■
■■
■■
■■
■■
Default and breach of contract provisions that may be included in the contract
include the following:
■■ Rescission
■■ Suit for money damages
■■ Suit for specific performance
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UNIT 5 REVIEW QUESTIONS
1. In a standard sales contract, several words were crossed out or inserted by the parties. To eliminate future
controversy as to whether the changes were made before or after the contract was signed, the usual procedure is to
a. write a letter to each party listing the changes.
b. have each party write a letter to the other approving the changes.
c. redraw the entire contract.
d. have both parties initial or sign in the margin near each change.
2. A broker uses earnest money placed in the company trust account to pay for the rent owed on the broker’s
office. Using escrow funds for this purpose is
a. commingling of funds and is illegal.
b. legal if the trust account is reimbursed by the end of the calendar month.
c. legal if the seller gives consent in writing.
d. conversion of funds and is illegal.
3. A sales contract may include additional details, such as any of the following EXCEPT
a. a legal description of the land.
b. a statement of the form of deed to be delivered by the seller.
c. a history of previous owners of the property.
d. the kind of title evidence to be provided.
4. An offer to purchase by a potential buyer is considered accepted when the
a. seller signs the contract.
b. buyer is notified that the seller has accepted the offer.
c. seller notifies the listing broker.
d. seller initials any changes.
5. A buyer makes an offer to purchase certain property listed with a licensee and leaves an escrow deposit with
the licensee to show good faith. The broker should
a. immediately apply the deposit to the listing expenses.
b. put the deposit in an account, as provided by state law.
c. give the deposit to the seller when the offer is presented.
d. put the deposit in the broker’s personal checking account.
6. In describing real estate, the system that may use a property’s physical features to determine boundaries and
measurements is
a. rectangular survey.
b. metes and bounds.
c. government survey.
d. lot and block.
7. In any township, the number of the section designated as the school section is
a. 1.
b. 16.
c. 25.
d. 36.
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Unit 5 The Sales Contract
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8. The LEAST specific method for identifying real property is
a. rectangular survey.
b. metes and bounds.
c. street address.
d. lot and block.
9. When buyer default creates a breach of contract, the seller may take advantage of any of the following
remedies EXCEPT
a. rescission of the contract.
b. place a lis pendens.
c. sue for damages.
d. file a suit for specific performance.
10. The law that provides that the seller bear any loss due to destruction of the property before settlement is
called
a. “time is of the essence.”
b. suit for specific performance.
c. the Uniform Probate Code.
d. the Uniform Vendor and Purchaser Risk Act.
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6
U N I T
■■
LEARNING OBJECTIVES
Contingencies,
Addenda, and
Amendments
When you have completed this unit, you will be able to
■■
■■
■■
■■
■■
■■
■■
■■
■■
identify common contingencies included in sales contracts;
state the purpose for using a loan contingency;
identify the possible ramifications of an appraisal contingency;
explain the use of an approval of homeowner or condominium documents
contingency;
explain the types of inspections sometimes required or requested by a buyer;
identify types of hazardous substances frequently covered in an inspection
contingency;
discuss the benefits and the risks of allowing a sale of property
contingency;
describe an amendment and how and when it is used; and
describe an addendum and how and when it is used.
KEY TERMS
addendum
amendment
asbestos
carbon monoxide (CO)
contingency
home inspection
112
kick-out clause
loan-to-value ratio (LTV)
marketable title
mold
radon
short sale
synthetic stucco
underground storage tank
(UST)
walk-through items
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INTRODUCTION
The sale price is usually the first thing that sellers will look at when presented with
a contract, but it is often the other conditions that are included in the offer that
lead to the offer’s being either accepted or rejected. Sellers have been known to
accept a lower offer when other conditions better suited their own plans for the
future. In some cases, the decision may revolve around a requested contingency to
the contract or around financing versus cash.
CONTINGENCIES
Additional conditions that must be satisfied before a sales contract is fully enforceable are called contingencies. A contingency includes the following four elements:
1. The actions necessary to satisfy the contingency
2. The time frame within which the actions must be performed
3. How the contingency may be removed
4. Who is responsible for the cost (if applicable)
Many standard form contracts include the following:
■■ A loan contingency that protects the buyer’s earnest money until a lender
commits the loan funds
■■ An appraisal contingency to substantiate the purchase price and ensure that
the financing described in the contract is feasible
■■ A title contingency to ensure that the purchaser receives clear title to the
property
■■ An approval of homeowners or condominium association documents
contingency
Other common contingencies include the following:
■■ An inspection contingency may be requested for termites, wood-boring
insects, lead-based paint, structural and mechanical systems, sewage facilities, and radon or other toxic materials.
■■ A property sale contingency occurs when buyers make the sales contract
contingent on the sale of their current home. This protects the buyers from
owning two homes at the same time and also helps ensure the availability of
cash for the purchase.
■■ A third-party financing addendum is used any time there is a new loan of
any kind other than seller financing. Under this addendum, the buyer has
the burden to inform the seller that the buyer was unable to obtain financing
along the terms specified in the addendum. The promulgated form to be used
is the Third Party Financing Addendum for Credit Approval.
Loan Contingencies
Because of the difficulty of obtaining financing today, it has become even more
important that a sales contract be contingent on the buyer being able to obtain
the financing as described in the sales contract. Without a loan contingency, the
buyer is at risk of losing the earnest money deposit if unable to provide financing.
A preapproval letter from a lender makes for a much stronger contract (see Unit
7).
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The loan contingency is actually a protection for both the buyer and the seller.
If the buyer is not able to obtain the financing, the contract is void. The seller is
also protected as long as there is a set time limit for the buyer to provide proof of
the ability to obtain the described financing. This period should not be for more
than a week or two at most. If the buyer cannot fulfill this contingency, the seller
has an opportunity to void the contract and put the property back on the market.
In some states, the residential real estate purchase agreement automatically
includes a financing contingency as a default provision. As long as both parties
initial and complete the purchase agreement, the contingency is binding. A contract with an automatic financing contingency also provides for the contingency
to be automatically removed as soon as the buyer secures financing. The risk now
shifts from the seller to the buyer. Once the financing contingency is removed,
the buyer must complete the sales transaction or be in default. If the original
lender fails to come through with the financing offered to the buyer, either due
to changes in the lender’s capabilities or because the buyer provided incomplete
or false information in the loan application, the buyer will now be in default.
Some contracts provide that the full earnest money deposit is to be forfeited to
the seller if the buyer defaults. Otherwise, the seller may sue the buyer for breach
of contract.
P R A C T I C E A seller needs to review the financing contingency terms
carefully. If the financing that is described is not feasible (such as 2% interest with a
100% loan-to-value ratio), the buyer has an easy out when the financing cannot be
obtained or when a loan program is no longer available. For the buyer, the financing
needs to be described in sufficient detail to be within comfortable means; an acceptable rate of interest and number of points should be included.
I N
An Appraisal Contingency
An appraisal contingency is closely tied to the mortgage contingency. An appraisal
that comes in for less than the sales price, will most likely present a problem for
the buyer. A lender establishes a loan-to-value ratio (LTV) for different loan
programs. The LTV is the percentage of the sales price that the lender will allow a
buyer to borrow. An LTV of 80% will allow $80,000 to be borrowed on a $100,000
sales price; an LTV of 90% would allow for a $90,000 loan. In earlier years, many
lenders offered loans with 97% and even 100% LTV. As a result of the tightened
qualifying standards brought on by the economic crisis starting in 2007, anything
higher than a 95% LTV is rare. The only exceptions are with FHA loans that use
96.5% LTV and VA loans with 100% LTV.
P R A C T I C E A house sells for $200,000. The buyer’s lender will allow an
LTV of 90%, meaning that the lender will loan $180,000. If the house only appraises for
$190,000, the lender will still only loan 90% of the $190,000 or $171,000. If the buyer
does not have adequate funds to pay the difference in the down payment, the contract
will be in jeopardy.
I N
An appraisal contingency in the sales contract should state what happens in the
case of a low appraisal. Possible resolutions are
■■ the contract is automatically declared void,
■■ the buyer is given a certain amount of time to find a different loan program,
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Unit 6 Contingencies, Addenda, and Amendments
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■■ the buyer shows evidence of additional cash to increase the amount of down
payment, and
■■ the seller agrees to lower the sales price to the appraised amount.
Note that with a VA loan, the buyer has the right to void the contract, regardless
of a decrease in sales price.
A Title Contingency
Many form contracts include a paragraph stating that the seller will provide a
marketable title to the purchaser. The term marketable is the key word. When a
title search is made by a title and escrow company, certain defects in the title may
be found. In some cases, the title company is willing to “insure over the defect”
and provide title insurance to the new owner. However, the defect remains in
place and can present a problem for any future purchaser of the property. This
becomes a legal issue as to whether or not a marketable title is being conveyed and
may require consultation with an attorney.
Approval of Homeowners and Condominium Association
Documents Contingency
The regulation of homeowners and condominium associations varies according to
the state where the property is located, but whenever a condominium unit, or a
residence located within a community subject to homeowners association guidelines, is purchased, the purchaser must be made aware of the required obligations
and/or restrictions for residents in such developments.
State law may specify the exact forms and documents that must be provided to a
potential purchaser, but subjects certain to be covered include
■■ the amount of fees or dues to be paid monthly, quarterly, or annually;
■■ any requirements for maintenance upkeep or repairs;
■■ any restrictions on painting, fencing, or parking; and
■■ use of common-area facilities such as swimming pool, tennis courts, and
picnic or playground areas.
The seller is given a certain time frame to provide the required documents for the
purchaser; the purchaser is given a set time to respond with either approval or
rejection of the documents. The contingency should also include language that
provides that the purchaser’s earnest money deposit is to be returned without penalty if the documents are rejected. Because this puts the seller at risk for the duration of the contingency, the time frame given for the purchaser to either approve
or reject should be kept short. In some states, failure to provide these condominium or association documents for purchaser to review may give the purchaser legal
grounds to void the contract.
P R A C T I C E A young woman is making her first home purchase. She has
selected a two-bedroom condominium unit close to public transportation and featuring numerous amenities that are very attractive to her. She makes an offer to purchase on Tuesday, May 1. According to her state law, she must receive a package
of condominium documents within three business days. She then has three business
days to either accept or reject the documents. The seller’s agent delivers the condo
documents to the buyer’s agent on Thursday, May 3. The agent is not able to deliver
the documents because the purchaser is out of town on business and does not return
I N
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until Thursday, May 10. The state law specifies that if there is no response from the
purchaser within the stated time frame, the contingency may be considered removed
and the contract will be in full force. As long as this is agreeable with the purchaser,
there is no problem. However, while on the business trip, she was offered a new job
with a much higher salary but located in another city, and she no longer wants to buy
this property. Now she has a problem.
An Inspection Contingency
The time frame for an inspection contingency is very important. The seller has
taken the property off the market to allow the buyer to complete a requested
inspection. If problems arise as result of the inspection, it may take additional time
to reach a satisfactory resolution for both parties. Generally, a contingency for any
type of inspection does not extend more than 10 to 15 days. At the end of the
stated period, the purchaser will either sign off that the results of the inspection
were satisfactory or give notice to the seller that unless any defects uncovered by
the inspection are to be resolved, the contract will become void.
Home Inspection
The most common inspection contingency is for a home inspection. A home
inspection provides the buyer with the opportunity to learn valuable information
about the electrical, plumbing, and heating and cooling systems in the house; the
condition of appliances and the roof; and any signs of poor drainage causing water
in the basement. The selection of a home inspector is important. Most sellers will
not agree to have the home inspection done by anyone other than a licensed,
certified inspector. In some cases, a seller may even require that the inspector be a
member of the American Society of Home Inspectors (ASHI).
After the home inspection is completed, the purchaser can present the seller with
a list of defective items reported by the home inspector. If the seller is unwilling
to remedy the problems, the purchaser is free to terminate the contract with full
refund of earnest money deposit. In some cases, the seller may agree to correct
some of the listed defects, but not others. This becomes a counteroffer to the
buyer, who may then either accept the terms provided by the seller or make a
further counter. Hopefully, a compromise can be reached and the contract may
continue toward settlement. A seller who is unable or does not wish to make the
corrections required by the seller may offer a monetary amount of credit to be
given at settlement. This needs to be handled carefully, however, because it may
affect the terms of the financing being used for the purchase. Many loan programs
have a limitation on the amount of monetary credit that a seller may give to a
purchaser.
Unless a sales contract specifies that all systems and appliances are to be conveyed
in an as-is condition, it is customarily expected that plumbing, electrical, and
heating and cooling systems, along with appliances, will be in normal working
condition. The list of items that are either defective or in need of repair received
from a home inspector often includes items that fall under this category. It can
be helpful if the purchaser and the purchaser’s agent make separate lists of items
needing attention based on the home inspection and walk-through items that
will need to be brought into normal working condition before settlement.
The cost for a home inspection varies throughout the country and may be either
a set fee or based on a percentage of the value of the home. The home inspector
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Unit 6 Contingencies, Addenda, and Amendments
117
is basically a generalist—that is, having a lot of knowledge about the systems and
construction of a house, but not being an expert in any one field. For example, if
the home inspector notes a possible structural problem, the purchaser would be
referred to a structural engineer for consultation.
The Federal Housing Administration (FHA) requires that any potential purchaser
planning to obtain an FHA loan for the purchase of property be given the onepage flyer For Your Protection: Get a Home Inspection (see Figure 6.1). Although
only required for FHA loans, it is good advice for all purchasers.
Regulatory Inspections
Certain types of inspections may be required by either federal or state law.
Lead-Based Paint Federal law requires sellers and landlords to provide a disclosure of known lead-based paint hazards for any property built before 1978.
Although the law does not require the seller to test for the presence of lead-based
paint or to remove it, purchasers, especially those with small children, may require
that their contract be contingent on a satisfactory lead-based paint inspection. If
lead-based paint is found and the purchaser requires its removal, there are additional regulations for how the removal must be handled. See Figure 4.6 for the
disclosure form provided by the Environmental Protection Agency (EPA).
Termites Many states, especially those in the South, require a mandatory
inspection for termites or other wood-destroying insects for all properties being
sold. A termite inspection is not usually part of a home inspection but must be
contracted for separately. The responsibility for this inspection and any remedial
action is usually borne by the seller. Because the seller bears the responsibility
for correction of any problems, the purchaser may choose to select the inspector.
An inspector should be licensed by either the state’s Department of Agriculture
or the state agency responsible for regulating termite control within the state. In
Texas, inspectors are licensed by the Texas Department of Agriculture. Note that
termites can also cause problems in northern states, even Alaska.
Well and Septic Inspection of well and septic systems is regulated by local jurisdiction and is more common in suburban and rural areas. Specific guidelines generally detail the requirements for approval of these systems. A contingency for a
satisfactory well and septic inspection is often mandatory in some areas. If public
water and/or waste systems are available, the purchaser may be required to hook
up to these lines. A contingency dealing with any potential costs for installation
should be prepared to protect the purchaser in such case.
Underground Storage Tanks State and federal laws impose strict requirements
on landowners whose property contains underground storage tanks (USTs). EPA
regulations apply to tanks that contain hazardous substances or liquid petroleum
products that store at least 10% of their volume underground. Some states have
adopted laws that are even more stringent than the federal laws. A contingency
requiring inspection or removal of any underground storage tanks by the seller
before closing could save the purchaser from a great deal of later expense for
detection, removal, and cleanup of surrounding contaminated soil.
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FIGURE 6.1: For Your Protection: Get a Home Inspection
CAUTION
53$EPARTMENTOF(OUSING
AND5RBAN$EVELOPMENT
&EDERAL(OUSING!DMINISTRATION&(!
OMB Approval No: 2502-0538
(exp. 05/31/2014)
For Your Protection:
7HYA"UYER.EEDSA(OME)NSPECTION
!HOMEINSPECTIONGIVESTHEBUYERMOREDETAILEDINFORMATIONABOUTTHEOVERALLCONDITIONOFTHEHOMEPRIOR
TOPURCHASE)NAHOMEINSPECTIONAQUALIFIEDINSPECTORTAKESANINDEPTHUNBIASEDLOOKATYOURPOTENTIAL
NEWHOMETO
a%VALUATETHEPHYSICALCONDITIONSTRUCTURECONSTRUCTIONANDMECHANICALSYSTEMS
a)DENTIFYITEMSTHATNEEDTOBEREPAIREDORREPLACEDAND
a%STIMATETHEREMAININGUSEFULLIFEOFTHEMAJORSYSTEMSEQUIPMENTSTRUCTUREANDFINISHES
!PPRAISALSARE$IFFERENTFROM(OME)NSPECTIONS
!NAPPRAISALISDIFFERENTFROMAHOMEINSPECTION!PPRAISALSAREFORLENDERSHOMEINSPECTIONSAREFORBUYERS
!NAPPRAISALISREQUIREDTO
a%STIMATETHEMARKETVALUEOFAHOUSE
a-AKESURETHATTHEHOUSEMEETS&(!MINIMUMPROPERTYSTANDARDSREQUIREMENTSAND
a-AKESURETHATTHEPROPERTYISMARKETABLE
&(!$OES.OT'UARANTEETHE6ALUEOR#ONDITIONOFYOUR0OTENTIAL.EW(OME
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Unit 6 Contingencies, Addenda, and Amendments
119
Other Hazardous Substances
Depending on the potential purchaser’s personal concerns or requirements, a
number of other hazardous substances might cause purchasers to request a contingency for a satisfactory inspection.
Asbestos A fire-resistant mineral once used extensively as insulation and
to strengthen other building materials, asbestos was banned from use in 1978.
According to the EPA, it is still found in about 20% of the nation’s commercial
and public buildings, though not as often in residential property except for in
floor and ceiling tiles. Removal of asbestos requires state-licensed technicians and
specially sealed environments.
Radon Radon is a colorless, odorless, tasteless, radioactive gas produced by the
decay of radioactive substances. Purchasers who are particularly concerned about
the potential of cancer due to exposure to radon can make the contract contingent on a satisfactory radon inspection. If testing shows unsatisfactory levels of
radon, mitigation can be fairly simple by installing a pipe and a fan to draw the
radon up and out of the house.
Carbon Monoxide Incomplete combustion of burning fuels such as wood, oil,
and natural gas causes a by-product of carbon monoxide (CO). Because CO is
colorless, odorless, and tasteless, it can be quickly absorbed by the body without
warning. Some jurisdictions may mandate the placement of CO detectors, along
with required smoke detectors, in residential property. A contract can be contingent on either inspection of existing detectors or their placement in the property
for sale.
Mold The presence of mold can cause serious health problems if not removed.
There are no federal requirements for the disclosure of mold, although some states
do require such disclosure. Mold is primarily a moisture problem that can be corrected by repairing leaks, making changes to landscaping directing water away
from the building, and providing adequate ventilation. Some states now require
the disclosure of exterior insulation finish systems (EIFS), also called synthetic
stucco, which does not allow moisture to escape. Purchasers subject to allergies and asthma should consider including a contingency on the disclosure and
removal of any existing mold problems.
I N
P R A C T I C E The question of whether or not to require special inspections for hazardous conditions depends on the needs and concerns of the purchaser.
Someone with severe allergies may be concerned about mold; someone with small
children may be worried about lead-based paint; someone with a history of lung cancer in the family may be most concerned about possible radon. Since real estate
professionals have no way to discern these issues, they should make sure buyers are
fully aware of all the options.
A Property Sale Contingency
Except for first-time homebuyers, most people need to sell their present home
in order to move to another property. This may be a “move up” wish for a larger
home, one in a different neighborhood, or one with additional acreage. Unfortunately, when the overall real estate market is slow, as has been the case for several
years, it may take a long time for a property to sell. Most sellers are not willing to
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have the sale of their property contingent on the buyers selling their home. That
sale could be held in a pending position for a long time and possibly never be
executed.
As a compromise position, the seller could accept the offer to purchase but make it
contingent on the buyer’s accepting a kick-out clause. In Texas, the buyers agree
to a kick-out clause by making the sale contingent on the sale of their current
property; the kick-out clause is paragraph B of the Addendum for Sale of Other
Property by Buyer. This allows the seller to keep the property on the market with
full disclosure in the multiple listing service that there is a contract in place, but
other offers are welcome. If a new offer is made, there is a specified time (usually
no more than 24 to 72 hours) for the original buyers to remove the home sale
contingency and proceed with the contract. In most cases, the original buyers are
unable to do so and their contract becomes void, the earnest money deposit is
returned, and the new offer moves into place. Occasionally, the buyers have the
financial capability to remove the contingency.
In some cases, the contingency may specify that the buyers must list their home
with a real estate broker and make it available through the local multiple listing
service within a short period. Cautious sellers might even specify a price range for
the property to be listed. The listing broker should be able to provide the seller
with sales information indicating the probability of the buyer’s home being sold
within a reasonable time. If the buyers already have a ratified contract on their
home, the sellers might make the contract contingent on receiving a copy of that
sales agreement and information regarding the prospective buyers of that property.
These types of contingencies may be seen as an inappropriate invasion of the
buyer’s personal business, but the seller may not be willing to take any chances on
the contract falling out, especially if the sellers are in the process of purchasing
another property. The failure of the first contract can create a domino effect, causing all contracts to become void.
Some sellers may be flexible about a time for closing, but many are not. The sellers
may be planning to purchase another home in the area or may be making an offer
on a house located in the town or city where they are being transferred. Elder sellers may be moving into an assisted-living arrangement and will lose out on their
reservation unless their house is sold and settled by a certain time.
P R A C T I C E The buyers made their contract contingent on the sale of
their present property, although they actually have the funds needed to complete the
purchase if they redeem a part of their portfolio of stocks and bonds. When notified
that the kick-out clause is going into effect, they must act quickly to provide proof that
they have the funds available and are willing to remove the home sale contingency.
I N
The offer to purchase from the second set of purchasers should also be contingent
on voiding the original contract within a certain time frame.
In a reverse situation, the seller can make the contract contingent on the seller
being able to find a new home to purchase. In this case, the buyer needs to be
protected by having a specific time for the completion of this new purchase. If
the seller is being extremely picky or unrealistic about finding a home of choice,
the buyers could be held to a pending contract for a long time, only to have it
become void. If the buyers have also put their home on the market in anticipation
of making the move, and the buyers’ property sells, these buyers could end up with
nowhere to live.
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Unit 6 Contingencies, Addenda, and Amendments
121
Other Types of Contingencies
The variety of types of contingencies is only limited by the wants and needs of
either the buyer or the seller. Basically, a contract may be made contingent on
anything as long as the three components are met:
■■ What is it?
■■ How long is it good for?
■■ How can it be resolved?
Following are examples of contingencies related to a specific situation:
■■ On buyer’s being allowed to move in prior to settlement (raises questions of
liability, maintenance, repairs, and others)
■■ On seller’s renting back until children finish school where presently enrolled
■■ On seller’s providing a property disclosure report to buyer (this is actually
mandatory in some states)
■■ On purchaser’s being able to run an internet consultation business from the
home
■■ On verification of legal water rights for proposed use of the property
■■ On the ability of the land to percolate (necessary for septic fields)
■■ On removal of trash from the backyard
■■ On repainting of master bedroom
■■ On leaving existing washer and dryer in place
■■ On trimming trees in front yard
■■ On receiving approval from parents (particularly seen where parents are
providing money for down payment or closing)
■■ On purchasers’ getting married (VA loans require borrowers to be married)
■■ On appraisal of antique jewelry to be sold to provide funds for down
payment
A contract can be made contingent on the receipt of further information regarding issues particular to a specific geographic area (e.g., marine clay, sinkholes,
earthquake faults, coastal erosion, flood zones, or any other areas of concern to
the potential purchaser).
AMENDMENT
The written contract is generally considered the entirety of the agreement.
Changes to the terms or conditions that are made orally will be considered irrelevant in any later dispute. In order to make any changes to the existing contract, a
separate written amendment or addendum must be incorporated into the original
contract, as agreed upon and signed by all parties.
An amendment is a change or modification to the existing content of a contract.
Any time words or provisions are added to or deleted from the body of the contract, the contract has been amended. Once the original contract has been ratified
(signed by all parties), any changes need to be addressed in a separate form.
The Amendment to Contract form (see Figure 6.2) promulgated by TREC must
be used in connection with any amendment to the contract. The form has eight
specific common paragraph points, plus a designated space for “other modifications.” The amendment must always reference the original contract, listing the
parties involved, the date of ratification, and the legal address of the property. The
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amendment form may include space at the bottom for the recipient to accept,
reject, or counteroffer. The process continues until all parties have reached agreement or the amendment is declared void.
FIGURE 6.2: Amendment to Contract
PROMULGATED BY THE TEXAS REAL ESTATE COMMISSION (TREC)
12-05-11
AMENDMENT
EQUAL HOUSING
OPPORTUNITY
TO CONTRACT CONCERNING THE PROPERTY AT
(Street Address and City)
Seller and Buyer amend the contract as follows: (check each applicable box)
(1) The Sales Price in Paragraph 3 of the contract is:
A. Cash portion of Sales Price payable by Buyer at closing ........................... $
B. Sum of financing described in the contract................................................. $
C. Sales Price (Sum of A and B) ............................................................... $
(2) In addition to any repairs and treatments otherwise required by the contract, Seller, at Seller’s
expense, shall complete the following repairs and treatments:
(3)
(4)
(5)
(6)
(7)
(8)
(9)
The date in Paragraph 9 of the contract is changed to
, 20
.
The amount in Paragraph 12A(1)(b) of the contract is changed to $
.
The cost of lender required repairs and treatment, as itemized on the attached list, will be paid
as follows: $
by Seller; $
by Buyer.
Buyer has paid Seller an additional Option Fee of $
for an extension of the
unrestricted right to terminate the contract on or before
,
20
. This additional Option Fee will will not be credited to the Sales Price.
Buyer waives the unrestricted right to terminate the contract for which the Option Fee was paid.
The date for Buyer to give written notice to Seller that Buyer cannot obtain Credit Approval as
set forth in the Third Party Financing Condition Addendum for Credit Approval is changed
to
, 20
.
Other Modifications: (Insert only factual statements and business details applicable to this sale.)
EXECUTED the
day of
DATE OF FINAL ACCEPTANCE.)
, 20
Buyer
Seller
Buyer
Seller
. (BROKER: FILL IN THE
This form has been approved by the Texas Real Estate Commission for use with similarly approved or promulgated contract
forms. Such approval relates to this form only. TREC forms are intended for use only by trained real estate licensees. No
representation is made as to the legal validity or adequacy of any provision in any specific transactions. It is not intended for
complex transactions. Texas Real Estate Commission, P.O. Box 12188, Austin, TX 78711-2188, 512-936-3000 (http://
www.trec.texas.gov ) TREC No. 39-7. This form replaces TREC No. 39-6..
TREC NO. 39-7
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Unit 6 Contingencies, Addenda, and Amendments
123
The three most common amendments are presented as follows.
Paragraph 2
This is followed by about five typewritten lines in which to record any pertinent
information, but if that space is insufficient, then attach an exhibit and so note
in the space provided. The quantity and quality of the repairs should be specific
enough so that there is no disappointment on the part of either party. For example, if there is peeling paint on the fascia board, it would not be sufficient to write
“paint fascia.” Instead, write
“peeling paint on fascia board on the west side; repair as follows: Scrape
all loose paint, sand sufficiently smooth and then (when the temperature is
between 55 and 85 degrees Fahrenheit, prime with oil base paint. Clean,
scuff and then paint entire west side with Behr paint #S-G 760 Chocolate
Coco, semi-gloss paint.”
Here is another example: Instead of writing “put enough insulation in attic to
meet code,” write:
“(1) Remove all debris from attic, then (2) remove existing mineral wool
insulation. Prior to proceeding with Step 3, inform buyer that Steps 1 and 2
are complete and allow 48 hours for an inspection. (Note that notification
protocol is contained in the contract.) (3) Seal all gaps and install Energy
Star-approved insulation barriers around eight recessed “can” lighting fixtures. Install Owens-Corning loose-fill blown-in insulation to a minimum
of R-38.”
These two examples are demonstrations of specificity; agents are required to both
understand the condition and the fix that will be satisfactory to the customer/
client.
Paragraph 3
This clause is self-explanatory but is usually a disappointment to the parties
involved. Common reasons for the extension of time to close include
■■ unresolved repair issues,
■■ loan underwriter issues,
■■ contingent home sale closing delay, and
■■ title defect issues, usually regarding an estate.
Paragraph 6
This clause is used when the buyer wishes to have extra time, such as for further
inspections. After the general home inspection, the report may call for additional
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inspections or evaluations by specific contractors which may require additional
time, especially if the initial option period was short.
A standard form contract has a provision requiring closing
in 90 days. If the purchaser wanted settlement to occur within 60 days, this change
could be made during the offer and counteroffer period by striking the 90 days and
replacing it with 60 days, marking the margin with a cross-hatch for all parties to initial. However, if this change is to be made after all parties have signed off, a separate
amendment must be prepared requiring the signature of all parties. If one party is not
willing to agree to the amendment, the original contract remains in place.
F O R
E X A M P L E
Settlement is scheduled for May 15 in the sales contract. The
sellers want to amend the contract to have settlement on May 30 in order for their oldest child to graduate from high school while still living in the family’s present home.
In some cases, this would be agreeable to the buyers but not always. Suppose the
buyers are scheduled to settle on their present home on May 16. To change the date
of settlement on the new property would leave them without a place to live from May
16 to May 30.
I N
P R A C T I C E
ADDENDUM
An amendment amends or changes a provision in the original contract, while an
addendum provides additional material to augment the original contract. The
addendum must name the parties involved and include the date of ratification and
the legal address of the property.
There are many specified promulgated addendum choices in paragraph 22 of the
One to Four Family Residential Contract (Resale) (see Figure 5.1). One or more
boxes may be checked when using this paragraph.
Third Party Financing Addendum for Credit Approval
This form is used any time there is a new loan of any kind except seller financing.
The buyer has the burden to inform the seller that the buyer was unable to obtain
financing along the terms specified in the addendum.
Seller Financing Addendum
In any case where the seller has agreed to provide the financing for the sale, an
addendum needs to be prepared outlining all the credit terms, taxes and assessments, method and time of payment, required disclosures, title insurance, and any
other information pertinent to local jurisdiction regulations.
The seller has seven days to terminate the contract, even if the buyer does not
provide the documentation within the time specified in paragraph A. Paragraph
D(1) invites the seller to determine if there will be an alienation clause in the
deed of trust. Finally, the seller must decide if he wants to have the burden of collecting, paying, accounting for, and providing an escrow analysis every year.
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Unit 6 Contingencies, Addenda, and Amendments
125
Addendum for Property Subject to Mandatory Membership in a
Property Owners Association
The buyer and the buyer’s agent should ensure that they understand each clause in
this form. In paragraphs A and B, the actual amount of the fees required should be
ascertained in advance of having either party sign a blank check. The bold notice
just before the signature lines outlines repairs by the association; it is not unusual
for the buyer’s agent to prepare a repair request for items that the seller is not able
to perform.
Buyer’s Temporary Residential Lease
This form encompasses the attributes of a regular lease except that the entire
amount of the rent will be collected at closing. Another issue is the holdover
rent amount, which most buyers put at two or three times the market rent for the
property.
Loan Assumption Addendum
This form specifies whether the seller is released from liability in the note.
Addendum for Sale of Other Property by Buyer
Paragraph E is the “time is of the essence” provision. A seller who accepts this
contingency will usually give the buyer between one and three days to remove it
and will require an amount necessary to cover liquidated damages (usually about
3% of the selling price).
Addendum for Reservation of Oil, Gas and Other Minerals
This form is used when the seller is reserving part or all of the minerals. Great care
must be taken when discussing the use of this form with sellers, and it may be to
the sellers’ benefit to contact a lawyer.
Addendum for “Back-Up” Contract
An addendum is required whenever there are backup offers on a property. The
addendum should state that in the event the primary contract becomes void, the
backup contract becomes primary. Attention must be paid to disposition of earnest money, time frame for acceptance, and right of the buyer to terminate.
Note that the option fee and earnest money will be handled as if the contract were
moving forward. Also consider what happens if the first contract asks for an extension. There are two effective dates to think about: the one in the contract, which
is handled just like any other contract, and the amended effective date, which
starts when acceptance notice is given by the seller, at which all time periods in
the first contract start.
Addendum for Coastal Area Property
This disclosure requires the buyer to understand the potential boundary issue with
reference to the tidal action of waterways.
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Environmental Assessment, Threatened or Endangered
Species, and Wetlands Addendum
This form gives the buyer, at his own expense, an opportunity to determine if
there are any environmental or wetland issues. The burden to remove this contingency rests with the buyer. It cannot be used as an excuse to terminate the
contract without a report that indicates that the property is adversely affected by
items specified in the form.
Seller’s Temporary Residential Lease
This form is used when the seller will occupy the property after the closing. If
the buyer is obtaining a Fannie Mae owner-occupied loan, this lease should not
extend beyond 60 days, even though it is good for up to 90 days. The deed of trust
requires the borrower to occupy the home within 60 days or default. Fannie Mae
and other lenders are required to perform quality control (QC) on loans, and they
primarily check whether the owner actually occupies the home within 60 days.
Short Sale Addendum
As a result of the economic crisis suffered in this country, many properties have
been sold as a short sale. Because short sales can be complex and difficult, shortsale addendum forms have been produced by TREC, lenders, multiple-listing services, and REALTOR® organizations that provide standard forms. Freddie Mac
provides a short-sale addendum form that is required of all servicers of Freddie
Mac loans.
Addendum for Property Located Seaward of the Gulf
Intracoastal Waterway
This form is used for waterfront properties and should be read carefully by the
buyer. The two primary issues are potential public access over the property and
erosion of the property due to tidal action and/or weather.
Addendum for Seller’s Disclosure of Information on Leadbased Paint and Lead-based Paint Hazards as Required by
Federal Law
Note that paragraphs B, C, and D must be checked and that paragraph F must be
signed by the buyer(s), seller(s), and both the listing agent and the selling agent.
Addendum for Property in a Propane Gas System Service Area
This required disclosure was developed to give information to any buyer that is
considering buying a property serviced by a propane distribution company. The
disclosure must be given to the buyer prior to execution of a binding contract.
SUMMARY
Contingencies are additional conditions that must be satisfied before a sales contract is fully enforceable. Three elements are necessary:
■■ The actions necessary to satisfy the contingency
■■ The time frame within which the actions must be performed
■■ How the contingency may be removed
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127
Unit 6 Contingencies, Addenda, and Amendments
Contingencies are often included in standard form contracts:
■■ Mortgage contingency—protects buyer’s earnest money
■■ Appraisal contingency—substantiates purchase price
■■ Title contingency—ensures buyer receives clear title
■■ Approval of homeowners or condominium association documents—mandated by state regulations
Other common contingencies include the following:
■■ Inspection contingency—home, regulatory, or hazard
■■ Property sale contingency—sale of buyer’s home
An amendment is a change to the original contract.
An addendum is additional information that is part of the original contract.
UNIT 6 REVIEW QUESTIONS
1. A seller willing to accept a contingency on the purchasers selling their present home would be protected by
all of the following EXCEPT
a. requiring the purchaser’s property to be entered in the MLS within 24 hours.
b. having the listing agent prepare a competitive market analysis on the purchaser’s home.
c. including a kick-out clause to allow continued marketing of the seller’s home.
d. leaving the termination date of the contingency open until the projected closing date.
2. On property built before January 1978, the obligation to provide a buyer with a lead-based paint disclosure
belongs to the
a. lender.
b. seller.
c. buyer’s broker.
d. listing broker.
3. Including a contingency in a sales contract makes the contract
a. valid.
b. void.
c. voidable.
d. unenforceable.
4. A contingency that might result in the seller lowering the sales price is a
a. mortgage contingency.
b. appraisal contingency.
c. title contingency.
d. inspection contingency.
5. A home inspector is considered a generalist. This means that the home inspector
a. has served in the military.
b. is an expert in all aspects of home construction.
c. is knowledgeable about most home systems and construction but is not an expert.
d. is similar to a general contractor.
6. The main difference between an amendment and an addendum is that an amendment
a. is a change to existing content in the contract.
b. is additional material to be added to a contract.
c. is the same as a contingency.
d. does not require signatures from all parties.
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7. The two most common inspections for a homebuyer are
a. home inspection and termite.
b. roof and termite.
c. home inspection and septic system.
d. septic and energy.
8. The short sale addendum may be used
a. if the commission will be less than 6%.
b. if the seller wishes to avoid capital gains tax.
c. when the final selling price will be less than the loan amount.
d. in none of these situations.
9. It is best to allow time between the inspection and the end of the option period because
a. sellers and agents will not extend option periods.
b. the buyer will be in breach if she does not complete all repairs prior to closing.
c. sellers are obligated to repair all health and safety issues prior to closing.
d. it gives time to negotiate repairs.
10. The contingency most often used for the buyer’s protection is the
a. inspection contingency.
b. loan contingency.
c. title contingency.
d. escrow closing contingency.
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7
U N I T
■■
LEARNING OBJECTIVES
Financing Real Estate
When you have completed this unit, you will be able to
■■
■■
■■
■■
■■
■■
■■
■■
■■
■■
identify the basic components of a promissory note;
define loan origination fee, discount points, and prepayment penalty;
explain a deed of trust and why lenders prefer it;
explain the use of a land contract or owner financing;
identify the two general types of foreclosure proceedings;
identify the types of institutions in the primary and secondary mortgage
markets;
describe the various types of financing techniques available;
discuss the significance of private mortgage insurance on conventional
loans;
compare FHA and VA government loans; and
examine the role of government financing regulations: Truth in Lending,
Equal Credit Opportunity, and Real Estate Settlement Procedures Acts.
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KEY TERMS
acceleration clause
adjustable-rate mortgage
(ARM)
alienation clause
amortized loan
annual percentage rate
(APR)
assume
balloon payment
beneficiary
buydown
certificate of eligibility
certificate of reasonable
value (CRV)
computerized loan
origination (CLO)
conforming loan
construction loan
conventional loan
deed in lieu of foreclosure
deed of trust
deficiency judgment
discount point
draws
equitable right of
redemption
Fannie Mae
Farmer Mac
Federal Home Loan Bank
(FHLB)
Federal Reserve System
(the Fed)
first mortgage or deed of
trust
foreclosure
Freddie Mac
Ginnie Mae
home equity line of credit
(HELOC)
home equity loan
hypothecation
impound or escrow
account
in arrears
index
interest
interest-only mortgage
land contract
lien theory
loan origination fee
loan-to-value ratio (LTV)
margin
mortgage
mortgage insurance
premium (MIP)
negotiable instrument
nonconforming loan
novation
package loan
payment cap
prepayment penalty
primary mortgage market
private mortgage
insurance (PMI)
promissory note
purchase-money
mortgage (PMM)
rate cap
Regulation Z
release deed
reverse mortgage
satisfaction
second mortgage or deed
of trust
secondary mortgage
market
straight loan
“subject to”
thrifts
trigger terms
trustee
trustor
Truth in Lending Act
(TILA)
usury
INTRODUCTION
Perhaps the most important investment decision most individuals ever make is
buying a home. In the United States, relatively few homes are purchased for cash.
Most homes are bought with borrowed money, and a huge lending industry has
been built to service the financial requirements of homebuyers. It was pointed
out in Unit 6 that a buyer can be protected by making the contract contingent
on the buyer’s being able to obtain a certain type of financing as described in the
contract. If the buyer cannot get funding to purchase the property, there can be
no transaction.
Although a typical sales contract only contains a paragraph or two regarding
financing, this unit provides an overall review of financing principles and practice
that can be an important asset for licensees who will be preparing the contract and
discussing financing options with a client.
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MORTGAGE LAW
A mortgage is a lien or encumbrance on real property. The borrower, or trustor,
receives a loan and in return gives a note and deed of trust to the lender. When
the loan is paid in full, the lender issues a release of lien. The deed of trust is a
voluntary, specific lien. If the debtor defaults, the lender can foreclose on the deed
of trust.
In lien theory states, the borrower retains both legal and equitable title. The
lender simply has a lien on the property as security for the debt. The deed of trust
is collateral for the loan. If the borrower defaults, the lender must go through a
formal foreclosure proceeding to obtain legal title. The property is offered for sale
at public auction, and the funds from the sale are used to pay the balance of the
remaining debt. In some states, a defaulting mortgagor may redeem (buy back) the
property during a certain period after the sale.
SECURITY AND DEBT
Mortgage loans are secured loans. Mortgage loans have two parts: the debt itself
and the security for the debt. When a property is mortgaged, the owner must
execute (sign) two separate instruments—a promissory note stating the amount
owed, and a security document, either a mortgage or deed of trust, specifying the
collateral used to secure the loan.
Hypothecation
In mortgage lending practice, a borrower is required to pledge specific real property as security (collateral) for the loan. The debtor retains the right of possession and control, while the creditor receives an underlying equitable right in the
pledged property. This type of pledging is termed hypothecation. The right to
foreclose on the pledged property in the event a borrower defaults is contained in
a security agreement, such as a mortgage or a deed of trust.
PROMISSORY NOTE
The promissory note, called the note or financing instrument, is the borrower’s
personal promise to repay a debt according to agreed terms.
A promissory note executed by a borrower is a contract complete in itself. It generally states the amount of the debt, the time and method of payment, and the rate
of interest. When signed by the borrowers, the note becomes a legally enforceable
and fully negotiable instrument of debt. When the terms of the note are satisfied,
the debt is discharged. If the terms of the note are not met, the lender may choose
to sue to collect on the note or to foreclose.
A note is a negotiable instrument like a check or bank draft. The lender who
holds the note is called the payee and may transfer the right to receive payment
by assigning the note to a third party.
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I N P R A C T I C E All notes should be clearly dated. Accurate dates are essential because time is of the essence in every real estate contract. Also, the dates of the
notes may be necessary to determine the chronological order of priority rights.
Interest
Interest is a charge for the use of money. A lender charges a percentage in interest
on the principal over the time of loan. Payments made at the end of a payment
period are called payments in arrears and are the general practice.
Usury Charging interest in excess of the maximum rate allowed by law is called
usury. To protect consumers from unscrupulous lenders, many states have enacted
laws limiting the interest rate that may be charged on loans. In most cases, usury
laws do not apply to depository institutions.
Loan Origination Fee
When a mortgage loan is originated, a loan origination fee is charged by most
lenders to cover the expenses involved in generating the loan. A loan origination
fee is not prepaid interest; it is a charge that must be paid to the originator. The
typical loan origination fee is 1% of the loan amount, although origination fees
may range from one to three points (one point equals 1% of the loan amount).
Discount points are used to increase the lender’s yield (rate of return) on its
investment. For example, the interest rate that a lender charges for a loan might
be less than the yield an investor demands. To make up the difference, the lender
charges the borrower discount points. The number of points charged depends on
two factors:
■■ The difference between the loan’s stated interest rate and the yield required
by the lender
■■ How long the lender expects it will take the borrower to pay off the loan
A point is 1% of the amount
being borrowed; it is not 1%
of the purchase price.
For borrowers, one discount point equals 1% of the loan amount and is charged
as prepaid interest at the closing. For example, three discount points charged on a
$100,000 loan are $3,000 ($100,000 × 3%, or 0.03). If a house sells for $100,000
and the borrower seeks an $80,000 loan, each point would be $800, not $1,000. In
some cases, the points in a new acquisition may be paid in cash at closing by the
buyer (or by the seller on the buyer’s behalf) rather than being financed as part of
the total loan amount.
Prepayment Penalty
Most mortgage loans are paid in installments over a long period. As a result, the
total interest paid by the borrower may add up to more than the principal amount
of the loan. If the borrower repays the loan before the end of the term, the lender
collects less than the anticipated interest. For this reason, some mortgage notes
contain a prepayment clause that requires the borrower to pay a prepayment
penalty for any payments made ahead of schedule. Lenders may not charge prepayment penalties on mortgage loans insured or guaranteed by the federal government or on those loans that have been sold to Fannie Mae or Freddie Mac.
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MORTGAGES OR DEEDS OF TRUST
In some states, lenders may use a three-party instrument called a deed of trust.
The deed is given as security for the loan to a third party, called the trustee. The
trustee holds bare title (no right of possession) on behalf of the lender, who is
called the beneficiary. The deed of trust establishes the actions that the trustee
may take if the borrower, the trustor, defaults under any of the deed of trust terms
(see Figure 7.1 for a comparison of mortgages and deeds of trust).
FIGURE 7.1: Mortgages and Deeds of Trust
Mortgage —Two Parties
When the Money Is Borrowed
Mortgagor
(Borrower)
Note and
Mortgage
When the Money Is Repaid
Mortgagor
(Borrower)
Loan $
Mortgagee
(Lender)
Pays the
Loan $
Satisfaction
of Mortgage
Mortgagee
(Lender)
Deed of Trust—Three Parties
When the Money Is Borrowed
When the Money Is Repaid
Trustor
(Borrower)
Loan
$
Note
Beneficiary
(Lender)
Trustor
(Borrower)
Deed of
Trust
Trustee
Pays the
Loan $
Beneficiary
(Lender)
Release Deed
or Deed of
Reconveyance
Trustee
In states where the deed of trust is commonly used, foreclosure procedures for
default are usually simpler and faster than for mortgage loans. In most cases, the
lender chooses the trustee and reserves the right to substitute trustees in the event
of death or dismissal.
A mortgage or deed of trust must clearly establish that the property is security
for a debt, identify the lender and the borrower, and include an accurate legal
description of the property. Both instruments incorporate the terms of the note
by reference. They should be signed by all parties who have an interest in the real
estate. Common provisions of both instruments are discussed in the following
paragraphs.
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Duties of the Mortgagor or Trustor
The borrower is required to fulfill certain obligations created by the mortgage or
deed of trust. These usually include the following:
■■ Payment of the debt in accordance with the terms of the note
■■ Payment of all real estate taxes on the property given as security
■■ Maintenance of adequate insurance to protect the lender if the property is
destroyed or damaged by fire, windstorm, or other hazard
■■ Maintenance of the property in good repair at all times
■■ Receipt of lender authorization before making any major alterations on the
property
Failure to meet any of these obligations can result in a borrower’s default. The
loan documents may, however, provide for a grace period (such as 30 days) during
which the borrower can meet the obligation and cure the default. If the borrower
does not do so, the lender has the right to foreclose the mortgage or deed of trust
and collect on the note.
Provisions for Default
The mortgage or deed of trust typically includes an acceleration clause to assist
the lender in foreclosure. If a borrower defaults, the lender has the right to declare
the entire debt due and payable immediately. Without an acceleration clause, the
lender would have to sue the borrower every time a payment was overdue.
Assignment of the Mortgage
Without changing the provisions of a contract, a note may be sold to a third
party, such as an investor or another mortgage company. The original mortgagee
endorses the note to the third party and executes an assignment of mortgage. The
assignee becomes the new owner of the debt and security instrument.
Release of the Mortgage Lien or Deed of Trust
When all loan payments have been made and the note has been paid in full, the
lender is required to execute a satisfaction. Entering this release in the public
record shows that the debt has been removed from the property. The release must
be executed and recorded by the assignee or mortgagee when the mortgage or deed
of trust has been assigned.
When a real estate loan secured by a deed of trust has been completely repaid,
the beneficiary must make a written request that the trustee execute and deliver a
release deed (sometimes called a deed of reconveyance) to the trustor. The release
deed should be acknowledged (notarized) and recorded in the public records of
the county in which the property is located.
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Tax and Insurance Reserves
Memory Tip
Recurring Monthly Costs
The basic recurring components of a borrower’s monthly
loan payment may be remembered as PITI:
■■ Principal
■■ Interest
■■ Taxes
■■ Insurance
Many lenders require that borrowers provide a reserve fund to meet future real
estate taxes and property insurance premiums. This fund is called an impound or
escrow account. When the mortgage or deed of trust loan is made, the borrower
starts the reserve by depositing funds to cover the amount of unpaid real estate
taxes. If a new insurance policy has just been purchased, the insurance premium
reserve will be started with the deposit of one-twelfth of the insurance premium
liability. The borrower’s monthly loan payments will include PITI: principal,
interest, taxes, and insurance. Other costs are included, such as flood insurance.
Federal regulations limit the total amount of reserves that a lender may require.
Buying “Subject to” or Assuming a Seller’s Mortgage or Deed
of Trust
When a person purchases real estate that has an outstanding mortgage or deed of
trust, the buyer may take the property in one of two ways. The property may be
purchased “subject to” the mortgage or deed of trust, or the buyer may assume
the mortgage or deed of trust and agree to pay the debt. Because this technical
distinction becomes important if the buyer defaults and the mortgage or deed of
trust is foreclosed, it is very important for the sale contract to accurately describe
which method is being used.
When the property is sold “subject to” the mortgage, the buyers are not personally
obligated to pay the debt in full. The buyers take title to the real estate knowing
that they must make payments on the existing loan. Upon default, the lender
forecloses and the property is sold by court order to pay the debt. If the sale does
not pay off the entire debt, the purchaser is not liable for the difference; however,
the original seller may continue to be liable.
In contrast, a buyer who purchases a property and assumes the seller’s debt
becomes personally obligated for the payment of the entire debt. If a seller wants
to be completely free of the original mortgage loan, the seller(s), the buyer(s), and
the lender must execute a novation agreement in writing. The novation makes
the buyer solely responsible for any default on the loan and the original borrower
(seller) is freed of any liability.
Because a loan may not be assumed without lender approval, the lending institution would require the assumer to qualify financially, and many lending institutions charge a transfer fee to cover the costs of changing the records.
Alienation Clause The lender may want to prevent a future purchaser of the
property from being able to assume the loan, particularly if the original interest
rate is low. For this reason, most lenders include an alienation clause ( also called
a due-on-sale clause or call clause) in the note. An alienation clause provides
that when the property is sold, the lender may either declare the entire debt due
immediately or permit the buyer to assume the loan at an interest rate acceptable
to the lender.
Recording a Mortgage or Deed of Trust
The mortgage document or deed of trust must be recorded in the recorder’s office
of the county in which the real estate is located. Recording gives constructive
notice to the world of the borrower’s obligations. Recording also establishes the
lien’s priority.
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Priority of a Mortgage or Deed of Trust
Priority of mortgages and other liens normally is determined by the order in which
they were recorded. A mortgage or deed of trust on land that has no prior mortgage lien is a first mortgage or deed of trust. If the owner later executes another
loan for additional funds, the new loan becomes a second mortgage or deed of
trust ( or a junior lien) when it is recorded. Second loans represent greater risk to
the lender, and they usually have a higher interest rate.
PROVISIONS OF LAND CONTRACTS AND OWNER FINANCING
Real estate can be purchased under a land contract, also called a contract for deed
or an installment contract (see Unit 3). Under a land contract, the buyer agrees
to make a down payment and a monthly loan payment that includes interest and
principal. The payment may also include real estate tax and insurance reserves.
The seller retains legal title to the property during the contract term, and the
buyer is granted equitable title and possession. At the end of the loan term, the
seller delivers clear title. The contract usually permits the seller to evict the buyer
in the event of default. In that case, the seller may keep any money the buyer has
already paid, which is construed as rent.
While land contracts or owner financing can occur with residential or commercial
properties, they are more common with unimproved acreage and farmland sales.
Sometimes the seller is the primary lender, and at other times, the seller may be in
a secondary position. In either case, the sellers would want to secure their interest
either by the use of a deed, note and mortgage, deed of trust, or perhaps the use of
a contract for deed instrument.
FORECLOSURE
When a borrower defaults on the payments or fails to fulfill any of the other obligations set forth in the mortgage or deed of trust, the lender’s rights can be enforced
through foreclosure. Foreclosure is a legal procedure in which property pledged as
security is sold to satisfy the debt. The foreclosure procedure brings the rights of
the parties and all junior lienholders to a conclusion. It passes title to either the
person holding the mortgage document or deed of trust or to a third party who
purchases the property at a foreclosure sale. The purchaser could be the mortgagee. The property is sold free of the foreclosing mortgage and all junior liens.
Methods of Foreclosure
There are two general types of foreclosure proceedings: judicial and non-judicial.
The specific provisions and procedures depend on state law.
Judicial Foreclosure Judicial foreclosure allows the property to be sold by
court order after the mortgagee has given sufficient public notice. When a borrower defaults, the lender may accelerate the due date of the remaining principal
balance, along with all overdue monthly payments and interest, penalties, and
administrative costs. The lender’s attorney can then file a suit to foreclose the lien.
After presentation of the facts in court, the property is ordered sold. A public sale
is advertised and held, and the real estate is sold to the highest bidder.
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Nonjudicial Foreclosure Some states allow nonjudicial foreclosure procedures
to be used when the security instrument contains a power-of-sale clause. In nonjudicial foreclosure, no court action is required. In those states that recognize deed
of trust loans, the trustee is generally given the power of sale. Some states allow a
similar power of sale to be used with a mortgage loan.
To institute a nonjudicial foreclosure, the trustee or mortgagee may be required
to record a notice of default at the county recorder’s office. The default must be
recorded within a designated period to give notice to the public of the intended
auction. The notice is generally provided by newspaper advertisements that state
the total amount due and the date of the public sale. After selling the property,
the trustee or mortgagee may be required to file a copy of a notice of sale or an
affidavit of foreclosure.
Deed in Lieu of Foreclosure
As an alternative to foreclosure, a lender may accept a deed in lieu of foreclosure
from the borrower. This is sometimes called a friendly foreclosure because it is
carried out by mutual agreement rather than by lawsuit. The disadvantage of the
deed in lieu of foreclosure is to the lender because it does not eliminate junior
liens. In a foreclosure action, all junior liens are eliminated. Also, by accepting a
deed in lieu of foreclosure, the lender usually loses any rights pertaining to FHA
or private mortgage insurance or to VA guarantees. Finally, it should be pointed
out that a deed in lieu of foreclosure is still considered an adverse component in
the borrower’s credit history.
Cure
Most states give defaulting borrowers a chance to redeem their property through
the equitable right of redemption. If, after default, but before the foreclosure sale,
the borrower (or any other person who has an interest in the real estate, such as
another creditor) pays the lender the amount in default, plus costs, the debt will
be reinstated. In some cases, the person who redeems may be required to repay
the accelerated loan in full. If some person other than the mortgagor or trustor
redeems the real estate, the borrower becomes responsible to that person for the
amount of the redemption.
Deed to Purchaser at Sale
If redemption is not made or if state law does not provide for a redemption period,
the successful bidder at the sale receives a deed to the real estate. In Texas, there is
generally no statutory right of redemption. An official such as a sheriff, an officer
of the court, or a trustee executes this deed to the purchaser to convey whatever
title the borrower had.
Deficiency Judgment
The foreclosure sale may not produce enough cash to pay the loan balance in full
after deducting expenses and accrued unpaid interest. In this case, the mortgagee
may be entitled to a deficiency judgment against the borrower for the unpaid balance. Any money that remains from the foreclosure sale after paying the debt and
any other liens (such as a second mortgage or a mechanic’s lien), expenses, and
interest is paid to the borrower.
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THE REAL ESTATE FINANCING MARKET
The real estate financing market has the following three basic components:
■■ Government influences, primarily the Federal Reserve System
■■ Primary mortgage market
■■ Secondary mortgage market
Under the umbrella of the financial policies set by the Federal Reserve System,
the primary mortgage market originates loans that are bought, sold, and traded in
the secondary mortgage market.
The Federal Reserve System
The role of the Federal Reserve System (the Fed) is to maintain sound credit
conditions, help counteract inflationary and deflationary trends, and create a
favorable economic climate. The Fed divides the country into 12 federal reserve
districts, each served by a federal reserve bank. All nationally chartered banks
must join the Fed and purchase stock in its district reserve banks. The Fed regulates the flow of money and interest rates in the marketplace through its member
banks by controlling their reserve requirements and discount rates.
The Primary Mortgage Market
The primary mortgage market is made up of the lenders that originate mortgage
loans. Income on the loan is realized from the following two sources:
■■ Finance charges collected at closing, such as loan origination fees and discount points
■■ Recurring income, the interest collected during the term of the loan
In addition to the income directly related to loans, some lenders derive income
from servicing loans for other mortgage lenders or investors who have purchased
the loans. Servicing involves
■■ collecting payments (including taxes and insurance),
■■ accounting,
■■ bookkeeping,
■■ preparing insurance and tax records,
■■ processing payments of taxes and insurance, and
■■ following up on loan payment and delinquency.
Some of the major lenders in the primary market for home mortgages include the
following:
■■ Thrifts, savings associations, and commercial banks. These institutions are
called fiduciary lenders because of their fiduciary obligations to protect and
preserve their depositors’ funds. Thrifts is a generic term for the savings
associations.
■■ Credit unions. Credit unions are cooperative organizations whose members
place money in savings accounts. In the past, credit unions made only shortterm consumer and home improvement loans. Now, they routinely originate
first and second mortgage and deed of trust loans.
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■■ Mortgage banking companies. Mortgage banking companies originate mortgage
loans with money belonging to insurance companies, pension funds, and
individuals, and with funds of their own. They make real estate loans with
the intention of selling them to investors and receiving a fee for servicing
the loans.
■■ Mortgage brokers. Mortgage brokers are not lenders. They are intermediaries
who bring borrowers and lenders together. Mortgage brokers locate potential
borrowers, process preliminary loan applications, and submit the applications to lenders for final approval. They do not service loans once the loans
are made.
A growing number of consumers apply for mortgage loans
via the internet. Many major lenders have websites that offer information to potential
borrowers regarding their current loan programs and requirements. In addition, online
brokerages link lenders with potential borrowers.
I N
P R A C T I C E
The Secondary Mortgage Market
In addition to the primary mortgage market, where loans are originated, there is a
secondary mortgage market. The secondary mortgage market helps lenders raise
capital to continue making mortgage loans.
In the secondary market, various agencies purchase a number of mortgage loans
and assemble them into packages (called pools). These agencies purchase the
mortgages from banks and savings associations. Securities that represent shares
in these pooled mortgages are then sold to investors or other agencies (see Figure
7.2).
FIGURE 7.2: Secondary Market and Makeup of Loan Packages
Institution
Secondary Market Function
Fannie Mae
Conventional, VA, FHA loans
Freddie Mac
Mostly conventional loans
Ginnie Mae
Special assistance loans
Federal Home
Loan Bank (FHLB)
Conventional loans
Farmer Mac
USDA/RHS loans
Fannie Mae (Federal National Mortgage Association) is a government-sponsored-enterprise (GSE) that purchases blocks or pools of both conventional and
government loans (FHA and VA). These blocks or pools of mortgages may then
be used as collateral for mortgage-backed securities that are sold on the global
market. Since September 2008, Fannie Mae, along with Freddie Mac, has been in
conservatorship under the Federal Finance Housing Agency (FHFA).
Freddie Mac (Federal Home Loan Mortgage Corporation) is also a GSE. It provides a secondary market for mortgage loans, primarily conventional loans.
Many lenders use the standardized forms and follow the guidelines issued by Fannie Mae and Freddie Mac for lenders that wish to sell mortgages in the agencies’
secondary mortgage market. The standardized documents include loan applications, credit reports, and appraisal forms.
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Ginnie Mae (Government National Mortgage Association) is a division of the
U.S. Department of Housing and Urban Development (HUD). Ginnie Mae
administers special-assistance programs and guarantees mortgage-backed securities using FHA and VA loans as collateral.
Federal Home Loan Bank (FHLB) is a GSE that purchases loans from its member savings associations (thrifts).
Farmer Mac (Federal Agricultural Mortgage Corporation) provides a secondary
market for loans originated by the U.S. Department of Agriculture Rural Housing
Service and the Farm Credit System.
FINANCING TECHNIQUES
Real estate financing comes in a wide variety of forms. While the payment plans
described in the following sections are commonly called mortgages, they are really
loans secured by either a mortgage or a deed of trust.
A straight loan (also called a term loan) essentially divides the loan into two
amounts to be paid off separately. The borrower makes periodic payments of interest only, followed by the payment of the principal in full at the end of the term.
Straight loans were once the only form of mortgage available. Today, they are
generally used for home improvement and second mortgages rather than for residential first mortgage loans.
An interest-only mortgage is a mortgage that requires the payment of interest
only for a stated period with the principal balance due at the end of the term. In
the past, interest-only mortgages were used primarily for short-term financing.
They became popular for a short time in the early years of the 2000 decade but
due to the economic crisis starting in 2007, interest-only loans are very rare today.
A balloon payment is required when the periodic payments are not enough to
fully amortize the loan by the time the final payment is due, resulting in the final
payment being much larger than the others. It is a partially amortized loan because
some of the principal is still owed at the end of the term.
Each payment in an amortized loan partially pays off both principal and interest.
Most mortgage and deed in trust loans are amortized loans. The word amortize
means to kill off. The loan is paid off in equal payments over a term of years (15
and 30 being the most common). Each payment is applied first to the interest
owed; the balance of the payment is then applied to the principal amount. As a
result, while each payment remains the same, the portion applied to repayment of
the principal grows and the interest due declines as the unpaid balance of the loan
is reduced. At the end of the term, the full amount of the principal and all interest
due is reduced to zero.
P R A C T I C E Financial calculators can accurately perform most standard
mortgage lending calculations, and most commercial lenders provide mortgage calculators on their websites. Nonetheless, it’s valuable to understand how the calculations are performed. A mortgage interest rate factor chart indicates the amount of
monthly payment per $1,000 of the loan, depending on the term and interest rate. This
factor is multiplied by the number of thousands of the amount borrowed (see Figure
7.3).
I N
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Adjustable-rate mortgages (ARMs) generally originate at one rate of interest,
then fluctuate up or down during the loan term, based on an economic indicator.
The loan payment changes when there is a change in the interest rate. Details of
how and when the interest rate will change must be included in the ARM note.
Common components of an ARM include the following:
■■ The index is an economic indicator that is used to adjust the interest rate in
the loan.
■■ The interest rate is the index rate plus a premium, called the margin. The
margin represents the lender’s cost of doing business.
■■ Rate caps limit the amount the interest rate may change. Most ARMs have
two types of rate caps. A periodic rate cap limits the amount the rate may
increase per adjustment period. A life-of-the-loan rate cap limits the amount
the rate may increase over the entire life of the loan.
■■ The mortgagor may be protected from unaffordable individual payments by a
payment cap. The payment cap sets a maximum amount for payments.
■■ The adjustment establishes how often the rate may be changed (monthly,
quarterly, or annually).
■■ Lenders may offer a conversion option that permits the mortgagor to convert
from an adjustable-rate to a fixed-rate loan at certain intervals during the life
of the mortgage.
A growing-equity mortgage uses a fixed interest rate, but payments of principal
are increased according to an index or a schedule. The total payment increases,
and the loan is paid off more quickly.
A reverse mortgage allows people 62 or older to borrow money against the equity
they have built in their home. Reverse mortgages are the opposite of conventional mortgages in that the homeowner’s equity diminishes as the loan amount
increases. The money may be used for any purpose and may be received in a lump
sum, fixed monthly payments, an open line of credit, or other options. The borrower is charged a fixed rate of interest and no payments are due until the property
is sold or the borrower defaults, moves, or dies. The FHA home equity conversion
mortgage (HECM) is the most common reverse mortgage.
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FIGURE 7.3: Mortgage Factor Chart
How to Use This Chart
Rate
Term 10
Years
Term 15
Years
Term 20
Years
Term 25
Years
Term 30
Years
To use this chart, start by
finding the appropriate
interest rate. Then follow that
row over to the column for the
appropriate loan term. This
number is the interest rate
factor required each month to
amortize a $1,000 loan.
3
9.66
6.91
5.55
4.74
4.22
3
9.71
6.97
5.61
4.81
4.28
3
9.77
7.03
5.67
4.87
4.35
3
9.83
7.09
5.74
4.94
4.42
3
9.89
7.15
5.80
5.01
4.49
3
9.95
7.21
5.86
5.07
4.56
3
10.01
7.27
5.93
5.14
4.63
3
10.07
7.33
5.99
5.21
4.70
4
10.13
7.40
6.06
5.28
4.78
4
10.19
7.46
6.13
5.35
4.85
4
10.25
7.53
6.20
5.42
4.92
4
10.31
7.59
6.26
5.49
5.00
4
10.37
7.65
6.33
5.56
5.07
4
10.43
7.72
6.40
5.63
5.15
4
10.49
7.78
6.47
5.71
5.22
4
10.55
7.85
6.54
5.78
5.30
5
10.61
7.91
6.60
5.85
5.37
5
10.67
7.98
6.67
5.92
5.45
5
10.73
8.04
6.74
6.00
5.53
5
10.80
8.11
6.81
6.07
5.60
To calculate the principal and
interest (PI) payment, multiply
the interest-rate factor by
the number of 1,000s in the
total loan. For example, if the
interest rate is 4% for a term
of 30 years, the interest-rate
factor is 4.78. If the total loan
is $100,000, the loan contains
100 $1,000s. Therefore, 100
× 4.78 = $478 PI only.
To estimate a mortgage loan
amount using the amortization chart, divide the PI
payment by the appropriate
interest-rate factor. Using
the same facts as in the first
example, the amount is calculated in this way:
$478 ÷ 4.78 = $100 $1,000s
or $100,000
5
10.86
8.18
6.88
6.15
5.68
5
10.92
8.24
6.95
6.22
5.76
5
10.98
8.31
7.03
6.30
5.84
5
11.04
8.38
7.10
6.37
5.92
6
11.10
8.44
7.16
6.44
6.00
6
11.16
8.51
7.24
6.52
6.08
61/4
11.23
8.57
7.31
6.60
6.16
6
11.29
8.64
7.38
6.67
6.24
6
11.35
8.71
7.46
6.75
6.32
6
11.42
8.78
7.53
6.83
6.40
6
11.48
8.85
7.60
6.91
6.49
6
11.55
8.92
7.68
6.99
6.57
7
11.61
8.98
7.75
7.06
6.65
7
11.68
9.06
7.83
7.15
6.74
71/4
11.74
9.12
7.90
7.22
6.82
7
11.81
9.20
7.98
7.31
6.91
7
11.87
9.27
8.05
7.38
6.99
7
11.94
9.34
8.13
7.47
7.08
7
12.00
9.41
8.20
7.55
7.16
7
12.07
9.48
8.29
7.64
7.25
8
12.14
9.56
8.37
7.72
7.34
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Other Financing Techniques
Because borrowers often have different needs, a variety of other financing techniques have been created. A few of those most applicable to residential home
mortgages are:
A purchase-money mortgage (PMM) is created when the seller agrees to finance
all or part of the purchase price and consists of a first or junior lien. PMM is often
used when the buyer does not qualify for a typical lender loan. The buyer/borrower executes a note and mortgage at the time of purchase; the seller records the
mortgage against the property. Payments are made to the seller, according to the
terms of the note; if the buyer stops making payments, the seller has recourse to
foreclose on the property.
E X A M P L E A man wants to buy a farm for $200,000. He has a $40,000
down payment and agrees to assume an existing mortgage of $80,000. Because
the buyer might not qualify for a new mortgage under the circumstances, the owner
agrees to finance a purchase-money second mortgage in the amount of $80,000. At
the closing, the buyer will execute a mortgage and note in favor of the owner, who will
convey title to the buyer.
F O R
A package loan includes real and personal property. This type of loan is popular
with developers and purchasers of furnished condominiums. Package loans usually include furniture, drapes, the kitchen range, refrigerator, dishwasher, washer,
dryer, food freezer, and other appliances as part of the sales price of the home.
A construction loan is made to finance the construction of improvements on real
estate such as homes, apartments, and office buildings. The lender commits to the
full amount of the loan but disburses the funds in payments during construction.
These payments are also called draws. Draws are made to the general contractor
or the owner for that part of the construction work that has been completed since
the previous payment. Before each payment, the lender inspects the work. The
general contractor must provide the lender with adequate waivers that release all
mechanics’ lien rights for the work covered by the payment.
Construction loans are generally short-term or interim financing. The borrower
pays interest only on the monies that have actually been disbursed. The borrower
is expected to arrange for a permanent loan, also called an end loan or takeout loan, which will repay the construction financing lender when the work is
completed.
A buydown is a way to temporarily (or permanently) lower the interest rate on
a mortgage or deed of trust loan. A lump sum is paid in cash to the lender at the
closing. The payment offsets (and so reduces) the interest rate and monthly payments during the mortgage’s first few years. Typical buydown arrangements reduce
the interest rate by 1% to 2% over the first one to two years of the loan term. After
that, the rate rises. In a permanent buydown, a larger up-front payment reduces
the effective interest rate for the life of the loan.
Home equity loans are a source of funds using the equity built up in a home. The
original mortgage loan remains in place; the home equity loan is junior to the
original lien. It is an alternative to refinancing and can be used for almost any
purpose.
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A home equity loan can be taken out as a fixed loan amount or as an equity line of
credit. With the home equity line of credit (HELOC), the lender extends a line
of credit that the borrower can use at will.
LOAN PROGRAMS
Mortgage loans are generally classified based on their loan-to-value ratio (LTV).
The LTV is the ratio of debt to value of the property. Value is the sales price or the
appraisal value, whichever is less. The lower the ratio of debt to value, the higher
the down payment by the borrower. For the lender, the higher down payment
means a more secure loan, which minimizes the lender’s risk.
P R A C T I C E If a property has an appraised value of $200,000, secured
by an $180,000 loan, the LTV is $180,000 ÷ $200,000 = 90%. An LTV of 95% on a
$100,000 loan allows $95,000 to be borrowed.
I N
Conforming Loans
Conventional loans are viewed as the most secure loans because their loan-tovalue ratios are often lowest. Traditionally, the ratio is 80% of the value of the
property or less because the borrower makes a down payment of at least 20%.
The secondary mortgage market has a significant impact on borrower qualifications, standards for the collateral, and documentation procedures followed by
lenders. Loans must meet strict criteria to be sold to Fannie Mae and Freddie Mac.
Lenders still can be flexible in their lending decisions, but they may not be able to
sell unusual loans in the secondary market.
To qualify for a conventional loan under Fannie Mae guidelines, the borrower’s
monthly housing expenses, including PITI (principal, interest, taxes, and insurance), must not exceed 28% of total monthly gross income. Also, the borrower’s
total monthly obligations, including housing costs plus other regular monthly payments, must not exceed 36% of total monthly gross income with 80% LTV loans.
Loans that meet these criteria are called conforming loans and are eligible to be
sold in the secondary market.
The Federal Housing Finance Agency (FHFA) publishes the
maximum loan limits for loans sold to Fannie Mae and Freddie Mac. In 2013, the
maximum loan limit for a single-family home ranged from $417,000 to $721,050 in
high-cost areas. Specific loan limits are established for each county (or equivalent).
I N
P R A C T I C E
Loans that do not meet the Fannie Mae/Freddie Mac guidelines are called nonconforming loans. Although there is a market for these loans, they often remain
held in the lender’s investment portfolio.
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Unit 7 Financing Real Estate
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E X A M P L E Following is the qualifying math for a $160,000 loan at 7.5%
interest for 30 years with payments of $1,200 per month in principal and interest:
F O R
Combined Monthly Gross Income: $8,000
Monthly Housing Expenses:
Principal and Interest
1,200
Property Taxes
400
Hazard Insurance
50
PMI Insurance
90
Homeowners Association Dues
+ Total Housing Expense
30
$1,770
$1,770 ÷ 8,000 = 22%
Debt Expense:
Installment Payments
$200
Revolving Charges
80
Auto Loan
250
Child Care
300
Other
+ 200
Total Debt Expense
$1,030
Plus Housing
+ $1,770
Grand Total
$2,800
$2,800 ÷ 8,000 = 35%
These borrowers will qualify for this loan under conventional loan guidelines of 28%
and 36%.
Private Mortgage Insurance
One way a borrower can obtain a conventional mortgage loan with a lower down
payment is by obtaining private mortgage insurance (PMI). In a PMI program,
the buyer purchases an insurance policy that provides the lender with funds in the
event that the borrower defaults on the loan.
PMI protects the top portion of a loan, usually 20% to 30%, against borrower
default. The borrower pays a monthly premium or fee that may be financed within
the loan. Because only a portion of the loan is insured, once the loan is repaid to
a certain level, the lender may agree to allow the borrower to terminate the PMI
coverage.
P R A C T I C E On loans originating after July 1999, federal law requires that
PMI automatically terminate if a borrower has accumulated at least 22% equity in the
home and is current on mortgage payments. The 22% of equity is based on the purchase price of the home, not on any appreciation of the property. Once the original
loan has been reduced to 80% LTV, the borrower can request removal of the PMI, but
the lender will require an appraisal.
I N
FHA-Insured Loans
The Federal Housing Administration (FHA), which operates under HUD, insures
lenders against loss from borrower default.
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The most popular FHA program is Title II, Section 203(b), fixed-interest-rate
loans for 10 to 30 years on one- to four-family residences. Rates are competitive
with other types of loans, even though they are high-LTV loans. Under this program, the borrower is eligible for approximately 96.5% financing for one- to fourunit structures. Certain requirements must be met before the FHA will insure the
loans. These requirements include the following:
■■ The borrower must pay a down payment of at least 3.5% of the purchase
price.
■■ The borrower is charged a mortgage insurance premium (MIP) for all FHA
loans. The up-front premium is charged at closing and can be financed into
the mortgage loan. The borrower is also responsible for paying an annual
premium that is charged monthly. The up-front premium is charged on all
FHA loans except those for the purchase of a condominium.
■■ The mortgaged real estate must be appraised by an approved FHA appraiser.
■■ The FHA sets maximum mortgage limits for various regions of the country.
■■ The borrower must meet standard FHA credit qualifications.
Financing for manufactured homes (factory-built housing) is also available along
with special programs such as the Good Neighbor Program that assists police officers, fire fighters, teachers, and emergency medical technicians (EMTs).
A qualified buyer may assume an existing FHA-insured loan. For loans originating after December 1, 1989, assumptions are only permitted with complete buyer
qualification.
Discount Points The lender of an FHA-insured loan may charge discount
points in addition to a loan origination fee. The payment of points is a matter of
negotiation between the seller and the buyer. If the seller pays more than 6% of
the costs normally paid by the buyer (such as discount points, the loan origination
fee, the mortgage insurance premium, buydown fees, prepaid items, and impound
or escrow amounts), the lender will treat the payments as a reduction in sales price
and recalculate the mortgage amount accordingly.
VA-Guaranteed Loans
The Department of Veterans Affairs (VA) is authorized to guarantee loans to
purchase or construct homes for eligible veterans and their spouses (including
unremarried spouses of veterans whose deaths were service-related). The VA also
guarantees loans to purchase manufactured homes and lots on which to place
them. A veteran who meets any of the following time-in-service criteria is eligible
for a VA loan:
■■ 90 days of active service for veterans of World War II, the Korean War, the
Vietnam conflict, and the Persian Gulf War
■■ A minimum of 181 days of active service during interconflict periods
between July 26, 1947, and September 6, 1980
■■ Two full years of service during any peacetime period since 1980 for enlisted
and since 1981 for officers
■■ Six or more years of continuous duty as a reservist in the Army, Navy, Air
Force, Marine Corps, or Coast Guard, or as a member of the Army or Air
National Guard
The VA assists veterans in financing the purchase of homes with little or no down
payments at market interest rates. The VA issues rules and regulations that set
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Unit 7 Financing Real Estate
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forth the qualifications, limitations, and conditions under which a loan may be
guaranteed and requires that the owner must live on the property.
There is no VA dollar limit on the amount of the loan a veteran can obtain; this
limit is determined by the lender and the qualification of the buyer. The VA limits
the amount of the loan it will guarantee.
The VA loan guarantee is tied to the current conforming loan
limit for Fannie Mae and Freddie Mac. Typically, lenders will loan four times the guarantee (e.g., a conforming loan of $417,000 ÷ 4 = $104,250 VA guarantee).
I N
P R A C T I C E
To determine what portion of a mortgage loan the VA will guarantee, the veteran
must apply for a certificate of eligibility that sets forth the maximum guarantee
to which the veteran is entitled. For individuals with full eligibility, no down payment is required for a loan up to the maximum guarantee limit.
The VA also issues a certificate of reasonable value (CRV) for the property being
purchased, which is the property’s current market value based on a VA-approved
appraisal. If the purchase price is greater than the amount cited in the CRV, the
veteran may pay the difference in cash but only with VA approval.
The VA borrower pays a loan origination fee to the lender, as well as a funding fee
(2% to 3%, depending on the down payment amount) to the VA. With no down
payment, the funding fee depends on whether it is first-time use (2.15%) or a subsequent use (3.3%). The funding fee drops with down payments of 5% or more.
Reservists and National Guard veterans pay higher funding fees. Reasonable discount points may be charged on a VA-guaranteed loan, and either the veteran or
the seller may pay them.
Assumption Rules For loans made on or after March 1, 1988, the VA must
approve the buyer and the assumption agreement. The original veteran borrower
remains personally liable for the repayment of the loan unless the VA approves a
release of liability. The release of liability will be issued by the VA only if
■■ the buyer assumes all the veteran’s liabilities on the loan, and
■■ the VA or the lender approves both the buyer and the assumption
agreement.
Releases are also possible if veterans use their own entitlement in assuming
another veteran’s loan.
Agricultural Loan Programs
The Farm Service Agency (FSA) is a federal agency of the Department of Agriculture. The FSA offers programs to help families purchase or operate family farms.
Through the Rural Housing Service (RHS), it also provides loans to help families
purchase or improve single-family homes in rural areas (generally areas with populations of fewer than 10,000 people).
The Farm Credit System (Farm Credit) provides loans to farmers, ranchers, rural
homeowners, agricultural cooperatives, rural utility systems, and agribusinesses.
Unlike commercial banks, Farm Credit System banks and associations do not take
deposits. Instead, loanable funds are raised through the system-wide sale of bonds
and notes in the nation’s capital markets.
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Farmer Mac Farmer Mac (Federal Agricultural Mortgage Corporation, or
FAMC) was created to improve the availability of long-term credit at stable interest rates to America’s farmers, ranchers, and rural homeowners, businesses, and
communities. Farmer Mac pools or bundles agricultural loans from lenders for sale
as mortgage-backed securities.
FINANCING LEGISLATION
The federal government regulates the lending practices of mortgage lenders
through the Truth in Lending Act (TILA), the Equal Credit Opportunity Act,
and the Real Estate Settlement Procedures Act (RESPA).
Both TILA and RESPA changed as of October 1, 2015. To find out more about the
changes, visit www.consumerfinance.gov/regulatory-implementation/tila-respa/.
Truth in Lending Act and Regulation Z
The federal Truth in Lending Act (TILA) requires that credit institutions inform
borrowers of the true cost of obtaining credit. Under TILA, a consumer must be
fully informed of all finance charges and the true interest rate before a transaction
is completed. The finance charge disclosure or truth-in-lending (TIL) statement
must include any loan fees, finder’s fees, service charges and points, as well as
interest. In the case of a mortgage loan made to finance the purchase of a dwelling,
the lender must compute and disclose the annual percentage rate (APR), which
includes the total amount of money being paid to the lender: interest, discount
points, and loan fees. The only accurate way to compare different loan programs
is to compare the APR for each. TILA provides for a three-day right of rescission
for many types of loans but not for home mortgages.
Regulation Z of TILA provides strict regulation of real estate advertisements (in
all media, including newspapers, flyers, signs, billboards, websites, radio or television ads, and direct mailings) that refer to mortgage financing terms.
Specific credit terms, such as down payment, monthly payment, dollar amount of
the finance charge, or term of the loan, are called trigger terms. These terms may
not be advertised unless the advertisement includes the following information:
■■ Cash price
■■ Required down payment
■■ Number, amounts, and due dates of all payments
■■ Annual percentage rate (APR)
Penalties The penalty for violation of Regulation Z is $10,000 for each day the
violation continues. In addition, a creditor may be liable to a consumer for twice
the amount of the finance charge. Willful violation is a misdemeanor punishable
by a fine of up to $5,000, one year’s imprisonment, or both.
Equal Credit Opportunity Act
The federal Equal Credit Opportunity Act (ECOA) prohibits lenders and others who grant or arrange credit to consumers from discriminating against credit
applicants on the basis of
■■ race,
■■ color,
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Unit 7 Financing Real Estate
■■
■■
■■
■■
■■
■■
149
religion,
national origin,
sex,
marital status,
age (provided the applicant is of legal age), or
dependence on public assistance.
Furthermore, lenders and other creditors must inform all rejected credit applicants
of the principal reasons for the denial or termination of credit. The notice must
be provided in writing within 30 days. The federal ECOA also provides that a
borrower is entitled to a copy of the appraisal report if the borrower paid for the
appraisal.
Real Estate Settlement Procedures Act
The federal Real Estate Settlement Procedures Act (RESPA) applies to any residential real estate transaction involving a new first mortgage loan. RESPA is
designed to ensure that the buyer and the seller are both fully informed of all
settlement costs. RESPA regulations will be covered in detail in Unit 9.
COMPUTERIZED LOAN ORIGINATION (CLO)
A computerized loan origination (CLO) system is an electronic network for
handling loan applications through remote computer terminals linked to lenders’
computers. Automated underwriting systems like Freddie Mac’s Loan Prospector
and Fannie Mae’s Desktop Underwriter reduce approval time to minutes.
Credit Scoring
Lenders today generally require a tri-merge credit report from the three major
credit reporting agencies: Equifax, Experian, and TransUnion. If the credit scores
are different, the lender usually takes the middle score. The higher the FICO
score, the less risk to the lender in making the loan.
SUMMARY
In a mortgage, the mortgagor (owner) borrows money from the mortgagee (lender),
and the real estate is used as security for the debt.
The term mortgage refers to any financing instrument by which real estate is used
as security for a debt. The mortgage can take the form of either a mortgage lien or
a deed of trust. In either case, a promissory note is attached. A mortgage is a twoparty agreement between a borrower and a lender. A deed of trust is a three-party
agreement that transfers title from the trustor (property owner) to a trustee, who
holds it on behalf of a borrower (lender).
The characteristics of both mortgage documents are similar, with the exception of
the foreclosure procedures for each.
■■ A mortgage document is executed by the borrower and recorded in the
county in which the property is located.
■■ When a loan is paid in full, a conveyance clause requires the lender to
execute a release of lien (release or discharge) that is recorded to clear title
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or resale
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(a deed
of of
reconveyance
deed ofof trust).
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■■ If the borrower defaults, the lender can accelerate the due date of the
remaining principal balance and all other payments and costs.
■■ The trustor transfers legal title to the beneficiary or trustee but retains equi-
table title and has the right to possession and use of the mortgaged property.
An impound (escrow) account may be required to create a reserve fund to ensure
that future tax, property insurance, and other payments are made.
When property with an outstanding mortgage or deed of trust is assumed, the new
owner may take title as follows:
■■ “Subject to” existing mortgage—the new owner makes payments on existing
loans but is not personally liable if the property is sold on default.
■■ Assuming the existing mortgage or deed of trust—the new owner takes personal responsibility for existing loans.
An alienation clause (due-on-sale clause) in a loan document will, at the lender’s
discretion, prevent future purchasers of the property from assuming the loan.
A novation agreement may be used to release the seller from any future liability
on loans secured by the real estate.
The Federal Reserve System (the Fed) consists of 12 federal reserve district banks.
The primary mortgage market consists of lenders that earn income from
■■ finance charges collected at loan closing, including loan origination fees, and
discount points;
■■ recurring income—interest collected during the term of loan;
■■ funds generated by the sale of loans to the secondary mortgage market; and
■■ fees for loan servicing for other mortgage lenders or investors who have
purchased the loans.
The primary mortgage market lenders include the following:
Depository institutions (thrifts, savings associations, and commercial banks)
Credit unions
Mortgage bankers
Mortgage brokers
Private lenders
■■
■■
■■
■■
■■
The secondary mortgage market, where loans are bought and sold after being
funded, does the following:
■■ Provides additional funds to lenders to make more loans, with lenders often
retaining servicing functions for a fee (seller/servicers)
■■ Purchases mortgage loans through agencies, assembles them into packages
called pools, and sells them as securities
Secondary market players are as follows:
■■ Fannie Mae creates mortgage-backed securities using pools of conventional,
FHA, and VA loans.
■■ Freddie Mac purchases mortgages, pools them, and sells as securities on the
open market.
■■ Ginnie Mae is a division of the Department of Housing and Urban Development (HUD) that administers special-assistance programs and guarantees
mortgage-backed securities based on FHA and VA loans.
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Unit 7 Financing Real Estate
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■■ The Federal Home Loan Bank purchases loans from member banks.
■■ Farmer Mac purchases agriculture/rural loans.
The following are types of financing:
■■ Straight loan (term loan or interest-only loan)—periodic payments of interest only for the life of the loan, with payment of principal in full at the end
of the loan term
■■ Balloon payment (partially amortized) loan—periodic payments of interest
and principal are not great enough to pay down entire amount borrowed by
the end of the loan term, resulting in a larger final payment
■■ Amortized (fully amortized) loan—equal periodic payments of interest and
principal, resulting in complete payment of amount borrowed over the term
of the loan
■■ Adjustable-rate mortgage (ARM)—lower initial rate of interest that may
change over the life of the loan, based on a specified index, usually tied to
U.S. Treasury securities
■■ Growing equity (rapid payoff) mortgage—fixed interest rate, but payments of
principal are increased according to an index or schedule so that the loan is
paid off more quickly
■■ Reverse mortgage—payments made by the lender to the borrower at regular intervals (such as monthly), in a lump sum, or as a line of credit to be
drawn against, allowing the borrower to remain in the home while receiving
income
Other types of loans include the following:
■■ A purchase-money mortgage is a note and mortgage created at the time of
purchase.
■■ The package loan includes all personal property and appliances, as well as
real estate.
■■ Construction loans finance the construction of property improvements.
■■ A buydown is a payment made at closing to reduce the interest rate on the
loan.
■■ A home equity loan (home equity line of credit, or HELOC) is junior to the
original lien.
Conventional loans are the most secure loans. Note the following:
■■ The loan-to-value ratio (LTV) is often lowest for these loans—traditionally
80%—meaning the down payment is 20%.
■■ Conforming loans meet all the requirements of the secondary market, set by
Fannie Mae and Freddie Mac, for conforming loans, including the following:
—— The borrower’s monthly housing expenses, including PITI, should be no
more than 28% of total monthly gross income.
—— The borrower’s total monthly obligations, including housing costs and
other regular monthly payments, must not exceed 36% of the total
monthly gross income.
■■ Nonconforming loans do not meet conforming guidelines; may be retained
in the lender’s investment portfolio.
■■ Private mortgage insurance (PMI) required for LTVs higher than 80% (down
payments of less than 20%). Federal law requires PMI to automatically terminate if the borrower has accumulated 22% equity in the home (based on
purchase price) and is current on mortgage payments.
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FHA-insured loans are backed by the Federal Housing Administration (FHA),
which is part of HUD. FHA does not make loans but insures loans made by an
FHA-approved lending institution.
FHA mortgage insurance premium (MIP) has an up-front fee along with monthly
installments. The premium can be financed within the loan.
VA-guaranteed loans are backed by the Department of Veterans Affairs and are
available to eligible veterans and spouses.
The Rural Housing Service (RHS) is part of the Department of Agriculture and
has the following programs to help families purchase or operate family farms:
■■ Farm Credit System (Farm Credit)
■■ Farmer Mac (formerly Federal Agricultural Mortgage Corporation), which
purchases farm loans
The Truth in Lending Act, Regulation Z of the Federal Trade Commission (FTC),
requires that when a loan is secured by a residence, lenders inform borrowers of
the true cost of obtaining credit, within the following rules:
■■ The borrower has a three-day right of rescission (not on mortgage loans).
■■ Advertising is strictly regulated.
■■ There is a $10,000 penalty for each day the violation continues.
The Equal Credit Opportunity Act (ECOA) prohibits discrimination in granting
or arranging credit on the basis of race, color, religion, national origin, sex, marital status, age (as long as the applicant is not a minor), or dependence on public
assistance.
The Real Estate Settlement Procedures Act ensures that buyers and sellers are
fully informed of all costs of settlement.
Computerized loan origination (CLO) is an electronic network for handling loan
applications.
Automated underwriting (loan processing) programs include Fannie Mae’s Desktop Underwriter and Freddie Mac’s Loan Prospector.
Credit scoring has become an important part of the loan application evaluation
process.
UNIT 7 REVIEW QUESTIONS
1. A prospective buyer needs to borrow money to buy a house. The buyer applies for and obtains a real estate
loan from a mortgage company. Then the buyer signs a note and a mortgage. In this example, the buyer is
called the
a. mortgagor.
b. beneficiary.
c. mortgagee.
d. vendor.
2. Which clause would give a lender the right to have all future installments become due upon default?
a. Escalation
b. Defeasance
c. Alienation
d. Acceleration
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153
Unit 7 Financing Real Estate
3. Which of the following is NOT a participant in the secondary market?
a. Fannie Mae
b. Ginnie Mae
c. Credit union
d. Freddie Mac
4. If buyers seek a mortgage on a single-family house, they would be LEAST likely to obtain the mortgage
from a
a. mutual savings bank.
b. life insurance company.
c. credit union.
d. commercial bank.
5. The primary activity of Freddie Mac is to
a. guarantee mortgages with the full faith and credit of the federal government.
b. buy and pool blocks of conventional mortgages.
c. act in tandem with Ginnie Mae to provide special assistance in times of tight money.
d. buy and sell VA and FHA mortgages.
6. Which characteristic of a fixed-rate home loan that is amortized according to the original payment schedule
is TRUE?
a. The amount of interest to be paid is predetermined.
b. The loan cannot be sold in the secondary market.
c. The monthly payment amount will fluctuate each month.
d. The interest rate change may be based on an index.
7. Funds for Federal Housing Administration (FHA) loans are usually provided by
a. the FHA.
b. the Federal Reserve.
c. approved lenders.
d. the seller.
8. A home is purchased using a fixed-rate, fully amortized mortgage loan. Which statement regarding this
mortgage is TRUE?
a. A balloon payment will be made at the end of the loan.
b. Each principal and interest mortgage payment amount is the same.
c. Each mortgage payment reduces the principal by the same amount.
d. The principal amount in each payment is greater than the interest amount.
9. The federal Equal Credit Opportunity Act allows lenders to discriminate against potential borrowers on the
basis of
a. race.
b. sex.
c. age.
d. amount of income.
10. Which law requires that all advertising that references mortgage financing terms contain certain
disclosures?
a. Equal Credit Opportunity Act
b. Fair Housing Act
c. Community Reinvestment Act
d. Truth in Lending Act (Regulation Z)
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8
U N I T
■■
LEARNING OBJECTIVES
Conveyance of Title
When you have completed this unit, you will be able to
■■
■■
■■
■■
■■
■■
■■
■■
■■
■■
■■
■■
■■
154
list the basic requirements for a valid deed;
describe the most common types of deeds;
illustrate how transfer tax may be assessed on a conveyance of property;
explain how property may be transferred through voluntary and involuntary
alienation, including a discussion of adverse possession;
explain the difference in someone dying testate and intestate and the effect
on potential heirs;
review the legal requirements for making a will;
identify the purpose and procedures of probate;
explain the importance of recording documents in the public records;
describe constructive and actual notice;
distinguish between chain of title and abstract of title;
review the process and purpose of a title search;
discuss ways to show proof of ownership; and
compare what is included in title insurance policies.
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Unit 8 Conveyance of Title
155
KEY TERMS
abstract of title
acknowledgment
actual notice
adverse possession
attorney’s opinion of title
bargain and sale deed
certificate of title
chain of title
cloud on the title
codicil
constructive notice
deed
deed of trust
devise
general warranty deed
grantee
granting clause
grantor
habendum clause
heir
holographic will
intestate
involuntary alienation
marketable title
nuncupative will
power of attorney
priority
probate
quitclaim deed
reconveyance deed
recording
special warranty deed
suit to quiet title
testate
testator
title
title insurance
title search
transfer tax
trustee’s deed
voluntary alienation
will
INTRODUCTION
Transfer of title is an aspect of the real estate transaction generally handled by lawyers and title companies, rarely by the licensee. Nonetheless, as with other legal
aspects of the transaction, a licensee who is aware of the fundamentals of deeds
and title issues will know what kind of questions to ask. An informed licensee
will also know when to direct clients to other real estate professionals to avoid
potential title problems.
TITLE
The term title has two functions. Title to real estate means the right to or ownership of the land; it represents the owner’s bundle of legal rights (see Unit 2). Title
also serves as evidence of that ownership. A person who holds the title, if challenged in court, would be able to recover or retain ownership or possession of a
parcel of real estate. Title is just a way of referring to ownership; it is not an actual
printed document.
Real estate may be transferred voluntarily by sale or gift. Alternatively, it may be
transferred involuntarily by operation of law. Real estate may be transferred while
the owner lives or by will or descent after the owner dies.
VOLUNTARY ALIENATION
A grantor conveys property to a grantee.
■■ A grantee receives
property from a grantor.
■■ A deed is the instrument
that conveys property
from a grantor to a
grantee.
■■
Voluntary alienation is the legal term for the voluntary transfer of title. The
owner may voluntarily transfer title by either making a gift or selling the property.
To transfer during their lifetime, owners must use some form of document to show
the conveyance.
A deed is the written instrument by which an owner of real estate intentionally
conveys the right, title, or interest in the parcel of real estate to someone else.
The statute of frauds requires that all deeds be in writing. The owner who transfers
the title is called the grantor, and the person who acquires the title is called the
grantee. A deed is executed (or signed) by the grantor. To be able to execute a
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valid deed,
the grantor must have legal capacity (see Figure 8.1).
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FIGURE 8.1: Remembering Legal Terminology: “OR” Versus “EE”
Throughout this book, people are called grantors and grantees, trustors and trustees, mortgagors and
mortgagees, and so forth. This chart provides a guide for remembering the terminology.
Product
Person Giving the Product
Person Receiving the Product
Devise
Devisor
Devisee
Deed
Grantor
Grantee
Legacy
Legator
Legatee
Lease
Lessor
Lessee
Mortgage
Mortgagee
Mortgagor
Offer
Offeror
Offeree
Option
Optionor
Optionee
Sublease
Sublessor
Sublessee
Trust
Trustor
Trustee
Requirements for a Valid Deed
Although formal requirements vary, most states require that a valid deed contain
the following elements:
■■ Grantor who has the legal competency to execute (sign) the deed
■■ Grantee named with reasonable certainty to be identified
■■ Statement of consideration
■■ Granting clause (words of conveyance)
■■ Habendum clause (to define ownership taken by the grantee)
■■ Accurate legal description of the property conveyed
■■ Any relevant exceptions or reservations
■■ Signature of the grantor, which must be acknowledged (notorization)
■■ Delivery of the deed and acceptance by the grantee to pass title
A deed also may include a description of any limitations on the conveyance of
a full fee simple estate and a statement of any exceptions and reservations that
affect title to the property.
Grantor A grantor must be of lawful age, usually at least 18 years old. A deed
executed by a minor is generally voidable.
A grantor also must be of sound mind. Generally, any grantor who can understand the action is viewed as mentally capable of executing a valid deed. A deed
executed by someone who was mentally impaired at the time is voidable, but it is
not void. If, however, the grantor has been judged legally incompetent, the deed
will be void. Real estate owned by someone who is legally incompetent can be
conveyed only with a court’s approval.
The grantor’s name must be spelled correctly and consistently throughout the
deed. If the grantor’s name has changed since the title was acquired, as when a
person’s name changes with marriage, both names should be shown (for example,
“Mary Smith, formerly Mary Jones”).
Grantee To be valid, a deed must name a grantee. The grantee must be specifically named so that the person to whom the property is being conveyed can be
readily identified from the deed itself.
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Unit 8 Conveyance of Title
157
E X A M P L E Olive wanted to convey Whiteacre to her nephew, Jack
Jackson. In the deed, Olive wrote the following words of conveyance: “I, Olive Burbank, hereby convey to Jack all my interest in Whiteacre.” The only problem was that
Olive also had a son named Jack, a cousin Jack, and a neighbor Jack. The grantee’s
identity could not be discerned from the deed itself. Olive should have conveyed
Whiteacre “to my nephew, Jack Jackson.”
F O R
If more than one grantee is involved, the granting clause should specify their
rights in the property. For example, the clause might state that the grantees will
take title as joint tenants or tenants in common. This is especially important
when specific wording is necessary to create a joint tenancy.
Consideration A valid deed must contain a clause acknowledging that the
grantor has received consideration. Generally, the amount of consideration is
stated in dollars. When a deed conveys real estate as a gift to a relative, love and
affection may be sufficient consideration. In most states, it is customary to recite a
nominal consideration, such as “$10 and other good and valuable consideration.”
Granting Clause (Words of Conveyance) A deed must contain a granting
clause that states the grantor’s intention to convey the property. Depending on
the type of deed and the obligations agreed to by the grantor, the wording would
be similar to one of the following:
■■ “I, JKL, convey and warrant . . .”
■■ “I, JKL, remise, release, alienate, and convey . . .”
■■ “I, JKL, grant, bargain, and sell . . .”
■■ “I, JKL, remise, release, and quitclaim . . .”
A deed that conveys the grantor’s entire fee simple interest usually contains wording such as “to ABC and to her heirs and assigns forever.” If less than the grantor’s
complete interest is conveyed, such as a life estate, the wording must indicate this
limitation—for example, “to ABC for the duration of her natural life.”
Habendum Clause When it is necessary to define or explain the ownership
to be enjoyed by the grantee, a habendum clause may follow the granting clause.
The habendum clause begins with the words “to have and to hold.” Its provisions
must agree with those stated in the granting clause. For example, if a grantor conveys a time-share interest or an interest less than fee simple absolute, the habendum clause would specify the owner’s rights as well as how those rights are limited
(a specific time frame or certain prohibited activities, for example).
Legal Description of Real Estate To be valid, a deed must contain an accurate legal description of the real estate conveyed. Land is considered adequately
described if a professional surveyor can locate the property using the description.
Exceptions and Reservations A valid deed must specifically note any encumbrances, reservations, or limitations that affect the title being conveyed. This
might include such things as restrictions and easements that run with the land. In
addition to citing existing encumbrances, a grantor may reserve some right in the
land, such as an easement, for the grantor’s use. A grantor may also place certain
restrictions on a grantee’s use of the property. Developers often restrict the number of houses that may be built on each lot in a subdivision. Such private restrictions must be stated in the deed or contained in a previously recorded document,
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such as the subdivider’s master deed, that is expressly referred to in the deed. Many
of these deed restrictions have time limits and often include renewal clauses.
Signature of Grantor To be valid, a deed must be signed by all grantors named
in the deed. Some states also require witnesses to or notarization of the grantor’s
signature.
Most states permit a power of attorney (written specific authority) to sign legal
documents for a grantor (a power of attorney is not necessarily an attorney-atlaw). The person having power of attorney has written authority to execute and
sign one or more legal instruments for another person. Usually, the power of attorney must be recorded in the county where the property is located.
In some states, a grantor’s spouse is required to sign any deed of conveyance to
waive any marital or homestead rights. This requirement varies according to state
law and depends on the manner in which title to real estate is held. In Texas, any
conveyance of community property requires the signature of both spouses.
Many states still require a seal (or simply the word seal) to be written or printed
after an individual grantor’s signature. The corporate seal may be required of a
corporate grantor.
Acknowledgment An acknowledgment is a formal declaration under oath
that the person who signs a written document does so voluntarily and that the
signature is genuine. The declaration is made before a registered notary public or
an authorized public officer, such as a judge, justice of the peace, or some other
person, as prescribed by state law. An acknowledgment usually states that the person signing the deed or other document is known to the officer or has produced
sufficient identification to prevent a forgery. After verifying the person’s information, the notary public will sign and stamp the form, which allows the person to be
able to record the document, completely satisfying the instrument.
An acknowledgment is not essential to the validity of the deed unless it is required
by state statute. In Texas, acknowledgment is not required for validity. However, a
deed that is not acknowledged is not a completely satisfactory instrument. In most
states (including Texas), an unacknowledged deed is not eligible for recording.
Transfer of title requires both
delivery and acceptance of
the deed.
Delivery and Acceptance A title is not considered transferred until the deed
is actually delivered to and accepted by the grantee. The grantor may deliver the
deed to the grantee either personally or through a third party.
Title is said to pass only when a deed is delivered and accepted. The effective date
of the transfer of title from the grantor to the grantee is the date of delivery of the
deed itself. Delivery and acceptance are usually presumed if the deed has been
examined and registered by the county clerk.
Execution of Corporate Deeds
The laws governing a corporation’s right to convey real estate vary from state to
state. However, two basic rules must be followed:
■■ A corporation can convey real estate only by authority granted in its bylaws
or on a proper resolution passed by its board of directors. If all or a substantial portion of a corporation’s real estate is being conveyed, a resolution
authorizing the sale usually must be secured from the shareholders.
■■ Deeds to real estate can only be signed by an authorized officer.
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Unit 8 Conveyance of Title
Types of Deeds
A deed can take several forms, depending on the extent of the grantor’s promises
to the grantee. Regardless of any guarantees the deed offers, the grantee will want
additional assurance that the grantor has the right to offer what the deed conveys.
To obtain this protection, grantees commonly seek evidence of title.
The most common deeds are the following:
■■ General warranty deed
■■ Special warranty deed
■■ Bargain and sale deed
■■ Quitclaim deed
General Warranty
Deed
Five covenants:
■■ Covenant of seisin
■■ Covenant against
encumbrances
■■ Covenant of quiet
enjoyment
■■ Covenant of further
assurance
■■ Covenant of warranty
forever
A general warranty deed provides the greatest protection to the buyer because
the grantor is legally bound by certain covenants (promises) or warranties. In most
states, the warranties are implied by the use of certain words specified by statute.
In some states, the grantor’s warranties are expressly written into the deed itself.
Each state law should be examined, but some of the specific words include convey
and warrant or warrant generally. The basic warranties are as follows:
■■ Covenant of seisin. Grantors warrant that they own the property and have the
right to convey title to it. (The term seisin simply means possession.) The
grantee may recover damages up to the full purchase price if this covenant is
broken.
■■ Covenant against encumbrances. The grantor warrants that the property is free
from liens or encumbrances, except for any specifically stated in the deed.
Encumbrances generally include mortgages, mechanics’ liens, and easements.
If this covenant is breached, the grantee may sue for the cost of removing
the encumbrances.
■■ Covenant of quiet enjoyment. The grantor guarantees that the grantee’s title
will be good against third parties who might bring court actions to establish
superior title to the property. If the grantee’s title is found to be inferior, the
grantor is liable for damages.
■■ Covenant of further assurance. The grantor promises to obtain and deliver
any instrument needed to make the title good. For example, if the grantor’s
spouse has failed to sign away dower rights, the grantor must deliver a quitclaim deed to clear the title.
■■ Covenant of warranty forever. The grantor promises to compensate the
grantee for the loss sustained if the title fails at any time in the future.
These covenants in a general warranty deed are not limited to matters that
occurred during the time the grantor owned the property; they extend back to its
origins. The grantor defends the title against both herself and all those who previously held title.
Special Warranty
Deed
Two warranties:
■■ Warranty that grantor
received title
■■ Warranty that property
was unencumbered by
grantor
A special warranty deed contains two basic warranties:
■■ That the grantor received title
■■ That the property was not encumbered during the time the grantor held
title, except as otherwise noted in the deed
In effect, grantors defend the title against themselves. The granting clause generally contains these words: “Grantor remises, releases, alienates, and conveys.” The
grantor may include additional warranties, but they must be specifically stated in
the deed. In areas where a special warranty deed is more commonly used, the purchase ofortitle
is viewed
asviolation
providing
adequate
protection
to the grantee.
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A special warranty deed may be used by fiduciaries such as trustees, executors, and
corporations. A special warranty deed is appropriate for fiduciaries because they
lack the authority to warrant against acts of predecessors in title (former owners).
A fiduciary may hold title for a limited time without having a personal interest
in the proceeds. Sometimes a special warranty deed is used by a grantor who has
acquired title at a tax sale.
Bargain and Sale
Deed
No express warranties:
■■ Implication that grantor
holds title and possession
A bargain and sale deed contains no express warranties against encumbrances.
However, it does imply that the grantor holds title and possession of the property.
The granting clause usually states a person’s name or name of an entity and the
words grants and releases or grants, bargains, and sells. Because the warranty is not
specifically stated, the grantee has little legal recourse if title defects appear later.
In some areas, this deed is used in foreclosures and tax sales. The buyer should
purchase, or the seller should provide, title insurance for protection.
A covenant against encumbrances initiated by the grantor may be added to a standard bargain and sale deed to create a bargain and sale deed with covenant against
the grantor’s acts. This deed is closely equivalent to a special warranty deed. Warranties used in general warranty deeds may be inserted in a bargain and sale deed
to give the grantee similar protection.
Quitclaim Deed
No express or implied
covenants or warranties:
■■ Used primarily to convey
less than fee simple or to
cure a title defect
A quitclaim deed provides the grantee with the least protection of any deed. It
carries no covenants or warranties and generally conveys only whatever interest
the grantor may have when the deed is delivered. If the grantor has no interest,
the grantee will acquire nothing. Nor will the grantee acquire any right of warranty claim against the grantor. A quitclaim deed can convey title as effectively
as a warranty deed if the grantor has good title when the deed is delivered, but it
provides none of the guarantees of a warranty deed. Through a quitclaim deed,
the grantor only “remises, releases, and quitclaims’’ the grantor’s interest in the
property, if any.
Usually, a quitclaim deed is the only type of deed that may be used to convey
less than a fee simple estate. This is because a quitclaim deed conveys only the
grantor’s right, title, or interest.
A quitclaim deed is frequently used to cure a defect, called a cloud on the title.
For example, if the name of the grantee is misspelled on a warranty deed filed in
the public record, a quitclaim deed with the correct spelling may be executed to
the grantee to perfect the title.
A quitclaim deed is also used when a grantor allegedly inherits property but is not
certain that the decedent’s title was valid. A warranty deed in such an instance
could carry obligations of warranty, while a quitclaim deed would convey only the
grantor’s interest, whatever it may be.
Another distinction between a grant deed and a quitclaim deed is after-acquired
title. In the grant deed, if the grantor does not have the title described in the deed
instrument, but subsequently acquires it, then it automatically transfers to the
grantee. The quitclaim deed not only has no warranties, but it does not convey
after-acquired title, which is the main distinction of this deed form.
A deed of trust (or deed in trust, in some states) is the means by which a trustor conveys real estate to a trustee for the benefit of the trustor. The real estate is
held by the trustee to fulfill the purpose of the trust (see Figure 8.2). This was also
discussed in Unit 7.
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Unit 8 Conveyance of Title
161
FIGURE 8.2: Trust Deeds
Deed of Trust
Trustor
Trustee
Reconveyance Deed
Reconveyance Deed
■■
Conveyance from trustee
back to trustor
Trustee’s Deed
■■
Conveyance from trustee
to third party
Beneficiary
Trustee’s Deed
A reconveyance deed is used by a trustee to return title to the trustor. For example, when a loan secured by a deed of trust has been fully paid, the beneficiary
notifies the trustee. The trustee then reconveys the property to the trustor. As
with any document of title, a reconveyance deed should be recorded to prevent
title problems in the future.
A deed executed by a trustee is a trustee’s deed. It is used when a trustee conveys
real estate held in the trust to anyone other than the trustor. The trustee’s deed
must state that the trustee is executing the instrument in accordance with the
powers and authority granted by the trust instrument.
Deed Executed Pursuant to a Court Order Executors’ and administrators’
deeds, masters’ deeds, sheriffs’ deeds, and many other types are all deeds executed
pursuant to a court order. These deeds are established by state statute and are used
to convey title to property that is transferred by court order or by will. The form of
such a deed must conform to the laws of the state in which the property is located.
One common characteristic of deeds executed pursuant to court order is that the
full consideration is usually stated in the deed. Instead of “$10 and other valuable
consideration,” for example, the deed would list the actual sales price.
Transfer Tax Stamps
Texas does not have a transfer tax, but many states have enacted laws providing
for a state transfer tax (also called a grantor’s tax in some states) on conveyances
of real estate. In these states, the tax is usually payable when the deed is recorded.
In some states, the taxpayer purchases stamps from the recorder of the county in
which the deed is recorded. The stamps must be affixed to deeds and conveyances
before the documents can be recorded. In other states, the taxpayer simply pays
the clerk of court or county recorder the appropriate transfer tax amount in accordance with state and local law.
The transfer tax may be paid by either the seller or the buyer, or split between
them, depending on local custom or agreement in the sales contract. The actual
tax rate varies and may be imposed at the state, county, or city level. For example,
the rate might be calculated as $1.10 for every $1,000 of the sales price, as $0.26
for every $500, or as a simple percentage.
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P R A C T I C E A state has a transfer tax of $1.50 for each $500 (or fraction
of $500) of the sales price of any parcel of real estate. The transfer tax is paid by the
seller. To calculate the transfer tax due in the sale of a $300,000 house, use the following formula:
I N
(value ÷ unit) × rate per unit = tax
In this example:
$300,000 ÷ $500 = 600 taxable units
600 × $1.50 = $900
The seller in this transaction must pay a transfer tax of $900 to the state.
In many states, a transfer declaration form (or transfer statement or affidavit of real
property value) must be signed by both the buyer and the seller or their agents.
The transfer declaration states
■■ the full sales price of the property;
■■ the property’s legal description;
■■ the type of improvement;
■■ the address, date, and type of deed; and
■■ whether the transfer is between relatives or in accordance with a court order.
Certain deeds may be exempted from the tax, such as the following:
■■ Gifts of real estate
■■ Deeds not made in connection with a sale (such as a change in the form of
■■
■■
■■
■■
■■
■■
■■
co-ownership)
Conveyances to, from, or between government bodies
Deeds by charitable, religious, or educational institutions
Deeds securing debts or releasing property as security for a debt
Partitions
Tax deeds
Deeds pursuant to mergers of corporations
Deeds from subsidiary to parent corporations for cancellations of stock
INVOLUNTARY ALIENATION
Title to property may be transferred without the owner’s consent by involuntary
alienation (see Figure 8.3). Involuntary transfers are usually carried out by operation of law, such as by condemnation or a sale to satisfy delinquent tax or mortgage liens. When a person dies intestate (with no will), the title to the real estate
passes to the state by the state’s power of escheat because there are no heirs. Land
may be acquired through the process of accretion or actually lost through erosion.
Other acts of nature, such as earthquakes, hurricanes, sinkholes, and mudslides,
may create or eliminate a landowner’s holdings.
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FIGURE 8.3: Involuntary Alienation
Action
Process
Property Taken By
Person dies intestate
no heirs
Escheat
State or county
Land needed for
public use
Eminent domain
Public or
government agency
Nonpayment of a
debt secured by
real property
Foreclosure
Creditor
Transfer by Adverse Possession
Open, notorious,
continuous, hostile,
possessorwho
Adversemeans
possession
and adverse Adverse
use of
possession is another
of involuntary transfer.Adverse
An individual
another’s property for
makes a claim to a certain property, takes possession of it and, most important,
prescriptive period
uses it, may take title away from an owner who fails to use or inspect the property
for a period of years. The law recognizes that the use of land is an important function of its ownership.
Usually the possession by the claimant must be all of the following:
Open (obvious to anyone who looks)
Notorious (known by others)
Continuous (uninterrupted)
Hostile (without the true owner’s consent)
Adverse (to the true owner’s possession)
■■
■■
■■
■■
■■
The necessary period of uninterrupted possession is a matter of state law. The
statutory periods range from as few as 5 years in some states to as many as 30 years
in others. Texas has four different time periods, which are 3, 5, 10, or 25 years.
Which time period applies depends on the circumstances by which the adverse
possessor came into possession.
In order to establish title by adverse possession, there must be proof of nonpermissive use that is actual, open, notorious, exclusive, and adverse for the statutorily
prescribed period. To claim title, the adverse possessor normally files an action in
court to receive undisputed title.
There is often some confusion between obtaining the right to property by way
of an easement by prescription versus adverse possession. The number of years
required in order to claim either varies from state to state. The prescriptive period
in Texas is 10 years.
The right of adverse possession is a statutory right. State
requirements must be followed carefully to ensure the successful transfer of title.
The parties to a transaction that might involve adverse possession should seek legal
counsel.
I N
P R A C T I C E
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CONVEYANCE OF A DECEDENT’S PROPERTY
A person who dies testate has prepared a will indicating how the deceased’s property will be disposed of. In contrast, when a person dies intestate (without a will),
real estate and personal property pass to the decedent’s heirs according to the
state’s statute of descent and distribution. In effect, the state makes a will for an
intestate decedent.
Legally, when a person dies, ownership of real estate immediately passes either to
the heirs by descent or to the persons named in the will. Before these individuals can take full title and possession of the property, the estate must go through a
judicial process called probate, and all claims against the estate must be satisfied.
Transfer of Title by Will
A will is made by an owner to convey title to real or personal property after the
owner’s death. This differs from a deed, which must be delivered during the lifetime of the grantor and which conveys a present interest in property. While the
testator, the person who makes a will, is alive, any property included in the will
can still be conveyed by the owner. The parties named in a will have no rights or
interests as long as the party who made the will is alive; they acquire interest or
title only after the owner’s death.
Only property owned by the testator at the time of the testator’s death may be
transferred by will. The gift of real property by will is called a devise, and a person
who receives real property by will is called a devisee. The other two gifts by will
are a bequest, which is a gift of personal property, and a legacy, which is a gift of
money.
For title to pass to the devisees, state laws require that on the death of a testator,
the will must be filed with the court and probated. Probate is a legal procedure for
verifying the validity of a will and accounting for the decedent’s assets. The process can take several months to complete. Probate is the formal judicial process.
A will cannot supersede the state laws of dower and curtesy, which were enacted
to protect the inheritance rights of a surviving spouse. When a will does not provide a spouse with the minimum statutory inheritance, the spouse may demand it
from the estate (see Unit 4).
Legal Requirements for Making a Will A will must be executed and prepared
according to the laws of the state in which the real estate is located. Only a valid
and probated will can effectively convey title to real estate.
A testator must have legal capacity to make a will. There are no rigid tests to
determine legal capacity. Usually, a person must be of legal age and of sound mind.
Legal age varies from state to state. To demonstrate sound mind, the testator must
have sufficient mental capacity to understand the nature and extent of the property the testator owns. Testators must understand the identity of their natural
heirs and that the property will go to those persons named in the will. The drawing of a will must be a voluntary act, free of any undue influence by other people.
In most states, a written will must be signed by its testator before two or more witnesses, who must also sign the document. The witnesses should not be individuals
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who are named as devisees in the will. Some states do not permit real property
to be conveyed by nuncupative wills (oral) or holographic wills (handwritten).
A testator may alter a will any time. Any modification, amendment, or addition
to a previously executed will is contained in a separate document called a codicil.
Transfer of Title by Descent
Under a state’s statute of descent and distribution, the primary heirs of the
deceased are the surviving spouse and close blood relatives (such as children, parents, brothers, sisters, aunts, uncles, and, in some cases, first and second cousins).
The right to inherit under laws of descent varies from state to state, and intestate
property is distributed according to the laws of the state in which the property is
located.
Probate Proceedings
Probate is a formal judicial process that
■■ proves or confirms the validity of a will,
■■ determines the precise assets of the deceased person, and
■■ identifies the people to whom the assets are to pass.
The purpose of probate is to see that the assets are distributed correctly. All assets
must be accounted for, and the decedent’s debts must be satisfied before any property is distributed to the heirs or devisee. In addition, estate taxes must be paid
before any distribution. The laws of each state govern the probate proceedings
and the functions of the individuals appointed to administer the decedent’s affairs.
Assets that are distributed through probate are those that do not otherwise distribute themselves. For example, property held in joint tenancy or tenancy by
the entirety passes immediately. Probate proceedings take place in the county in
which the decedent resided. If the decedent owned real estate in another county,
probate would occur in that county as well.
The person who has possession of the will—normally the person designated in the
will as executor—presents it for filing with the court. The court is responsible for
determining whether the will meets the statutory requirements for its form and
execution. If the will was modified or if more than one will exists, the court will
decide how these documents should be probated.
The court must rule on a challenge if a will is contested. Once the will is upheld,
the assets can be distributed according to its provisions. Probate courts distribute
assets according to statute only when no other reasonable alternative exists.
When a person dies intestate, the court determines who inherits the assets by
reviewing proof from relatives of the decedent and their entitlement under the
statute of descent and distribution. Once the heirs have been determined, the
court appoints an administrator or personal representative to administer the affairs
of the estate—the role usually taken by an executor.
P R A C T I C E A broker entering into a listing agreement with the executor
or administrator of an estate in probate should be aware that the amount of commission is approved by the court and that the commission is payable only from the
proceeds of the sale. The broker will not be able to collect a commission unless the
court approves the sale.
I N
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PUBLIC RECORDS
Public records are just that—records that are open to the public—which means
that anyone interested in a particular property can review the records to learn
about the documents, claims, and other details that affect its ownership. A prospective buyer, for example, needs to be sure that the seller can convey title to
the property. If the property is subject to any liens or other encumbrances, a prospective buyer or lender needs to know. An attorney or title company typically
performs a search of the public records to ensure that good title is being conveyed.
Nonetheless, it is important for a real estate licensee to understand what is in the
public record and what the searchers are likely to find.
Public records contain detailed information about each parcel of real estate in a
city or county. These records are crucial in establishing ownership, giving notice
of encumbrances, and establishing priority of liens. They protect the interests of
real estate owners, taxing bodies, creditors, and the public. The real estate recording system includes written documents that affect title, such as deeds and mortgages. Public records regarding taxes, judgments, probate, and marriage also may
offer important information about the title to a particular property.
Public records are maintained by
recorders of deeds,
county clerks,
county treasurers,
city clerks,
collectors, and
clerks of court.
■■
■■
■■
■■
■■
■■
P R A C T I C E Prospective buyers rarely search public records for evidence
of title or encumbrances themselves. Instead, title companies, attorneys, and lenders
conduct the searches.
I N
Recording
In most states, written
documents that affect land
must be recorded in the
county where the land is
located.
Recording is the act of placing documents in the public record. The specific rules
for recording documents are a matter of state law. Although the details may vary,
all recording acts essentially provide that any written document that affects any
estate, right, title, or interest in land must be recorded in the county (or, in some
states, the town) where the land is located to serve as public notice. This way,
anyone interested in the title to a parcel of property will know where to look to
discover the various interests of all other parties. Recording acts also generally
give legal priority to those interests recorded first—the first in time, first in right or
first come, first served principle.
An unrecorded deed has priority over a subsequent recorded instrument if it was
known to the subsequent party. The concept of recording is to impart “constructive” knowledge, which only controls if the subsequent recording parties had
actual notice of its existence.
To be eligible for recording, a document must be drawn and executed according
to the recording acts of the state in which the real estate is located. For example,
a state may require that the parties’ names be typed below their signatures or
that the document be acknowledged before a notary public. In some states, the
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document must be witnessed. Others require that the name of the person who
prepared the document appear on it. States may have specific rules about the
size of documents and the color and quality of paper they are printed on. Electronic recording—using computers or fax machines, for example—is permitted in
a growing number of localities. Some states require a certificate of real estate value
and the payment of current property taxes due for recording.
Notice
Anyone with an interest in a parcel of real estate can take certain steps, called
giving notice, to ensure that the interest is available to the public. The two basic
types of notice are constructive notice and actual notice.
Constructive notice is the legal presumption that information may be obtained
by an individual through due diligence. Properly recording documents in the public record serves as constructive notice to the world of an individual’s rights or
interest, as does the physical possession of a property. Because the information
or evidence is readily available to the world, a prospective purchaser or lender is
responsible for discovering the interest.
Actual notice means not only that the information is available but also that
someone has been given the information and actually knows it. An individual
who has searched the public records and inspected the property has actual notice,
also called direct knowledge. If it can be proved that an individual has had actual
notice of information, that person cannot use a lack of constructive notice (such
as an unrecorded deed) to justify a claim.
Priority
Priority refers to the order of when documents or liens were recorded. Many complicated situations can affect the priority of rights in a parcel of real estate—who
recorded first, which party was in possession first, or who had actual or constructive notice. How the courts rule in any situation depends, of course, on the specific
facts of the case. These are strictly legal questions that should be referred to the
parties’ attorneys.
E X A M P L E Buyer A purchased a property from seller B and received
a deed. A did not record the deed but took possession of the property in June. In
November, B sold the same property to buyer C who received a deed, which C
promptly recorded. C never inspected the property to determine whether someone
was in possession of it. By taking possession of the property, A has the superior right
to the property even though A did not record the deed.
F O R
Unrecorded Documents
Certain types of liens are not recorded. Real estate taxes and special assessments
are liens on specific parcels of real estate and are not usually recorded until sometime after the taxes or assessments are past due. Inheritance taxes and franchise
taxes are statutory liens and are placed against all real estate owned by a decedent
at the time of death or by a corporation at the time the franchise taxes became a
lien. Like real estate taxes, they are not recorded.
Notice of these liens must be gained from sources other than the recorder’s office.
Evidence of the payment of real estate taxes, special assessments, municipal
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utilities, and other taxes can be gathered from paid tax receipts and letters from
municipalities. Creative measures are often required to get information about off–
the-record liens.
Chain of Title
Chain of title is the record of a property’s ownership. Beginning with the earliest
owner, a title may pass to many individuals. Each owner is linked to the next so
that a chain is formed. An unbroken chain of title can be traced through linking
conveyances from the present owner back to the earliest recorded owner. Chain of
title does not include liens and encumbrances or any other document not directly
related to ownership.
If ownership cannot be traced through an unbroken chain, a gap or cloud in the
chain of title is said to exist. In these cases, the cloud on the title makes it necessary to establish ownership by a court action called a suit to quiet title. For
example, a suit might be required when a grantor acquired title under one name
and conveyed it under another name. Or there may be a forged deed in the chain,
after which no subsequent grantee acquired legal title.
Title Search and Abstract of Title
A title search is an examination of all of the public records to determine whether
any defects exist in the chain of title. The records of the conveyances of ownership are examined, beginning with the present owner. Then the title is traced
backward to its origin (or 40 to 60 years or some definite period, depending on
state statute). The time beyond which the title must be searched is limited in
states that have adopted the Marketable Title Act. This law extinguishes certain
interests and cures certain defects arising before the root of the title—the conveyance that establishes the source of the chain of title.
Other public records are examined to identify wills, judicial proceedings, and
other encumbrances that may affect title. These include a variety of taxes, special
assessments, and other recorded liens.
An abstract of title is a summary report of what the title search found in the public record. A person who prepares this report is called an abstractor. The abstractor searches all the public records and then summarizes the various events and
proceedings that affected the title throughout its history. The report begins with
the original grant (or root) and then provides a chronological list of recorded
instruments. All recorded liens and encumbrances are included, along with their
current status. A list of all of the public records examined is also provided as evidence of the scope of the search.
P R A C T I C E An abstract of title is a condensed history of those items that
can be found in public records. It does not reveal such items as encroachments or
forgeries or any interests or conveyances that have not been recorded.
I N
Marketable Title
Under the terms of the typical real estate sales contract, the seller is required to
deliver marketable title to the buyer at the closing. To be marketable, a title must
■■ disclose no serious defects and not depend on doubtful questions of law or
fact to prove its validity;
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■■ not expose a purchaser to the hazard of litigation or threaten the quiet
enjoyment of the property; and
■■ convince a reasonably well-informed and prudent purchaser, acting on busi-
ness principles and with knowledge of the facts and their legal significance,
that the purchaser could sell or mortgage the property at a later time.
Although a title that does not meet these requirements still can be transferred, it
contains certain defects that may limit or restrict its ownership. A buyer cannot
be forced to accept a conveyance that is materially different from the one bargained for in the sales contract. However, questions of marketable title must be
raised by a buyer before acceptance of the deed. Once a buyer has accepted a deed
with unmarketable title, the only available legal recourse is to sue the seller under
any covenants of warranty contained in the deed.
In some states, a preliminary title search is conducted as soon as an offer to purchase has been accepted. In fact, it may be customary to include a contingency
in the sales contract that gives the buyer the right to review and approve the title
report before proceeding with the purchase. A preliminary title report also benefits the seller by giving the seller an early opportunity to cure title defects.
PROOF OF OWNERSHIP
Proof of ownership is evidence that title is marketable. A deed by itself is not considered sufficient evidence of ownership. Even though a warranty deed conveys
the grantor’s interest, it contains no proof of the condition of the grantor’s title at
the time of the conveyance. The grantee needs some assurance that ownership is
actually being acquired and that the title is marketable. A certificate of title, title
insurance, or a Torrens certificate is commonly used to prove ownership.
Certificate of Title
A certificate of title is a statement of opinion of the title’s status on the date the
certificate is issued. A certificate of title is not a guarantee of ownership. Rather, it
certifies the condition of the title based on an examination of the public records—
a title search. The certificate may be prepared by a title company, licensed abstractor, or attorney. An owner, mortgage lender, or buyer may request the certificate.
Although a certificate of title is used as evidence of ownership, it is not perfect.
Unrecorded liens or rights of parties in possession cannot be discovered by a
search of the public records. Hidden defects, such as transfers involving forged
documents, incorrect marital information, incompetent parties, minors, or fraud,
cannot be detected. A certificate offers no defense against these defects because
they are unknown. The person who prepares the certificate is liable only for negligence in preparing the certificate.
An abstract and attorney’s opinion of title are used in some areas of the country
as evidence of title. It is an opinion of the status of the title based on a review of
the abstract. Similar to a certificate of title, the opinion of title does not protect
against defects that cannot be discovered from the public records. Many buyers
purchase title insurance to defend the title from these defects.
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Title Insurance
Title insurance is a contract under which the policyholder is protected from losses
arising from defects in the title. A title insurance company determines whether
the title is insurable, based on a review of the public records. If so, a policy is
issued. Unlike other insurance policies that insure against future losses, title insurance protects the insured from an event that occurred before the policy was issued.
Title insurance is considered the best defense of title: the title insurance company
will defend any lawsuit based on an insurable defect and pay claims if the title
proves to be defective.
After examining the public records, the title company usually issues what may be
called a preliminary report of title or a commitment to issue a title policy. This
describes the terms of policy that will be issued and includes
■■ the name of the insured party,
■■ the legal description of the real estate,
■■ the estate or interest covered,
■■ conditions and stipulations under which the policy is issued, and
■■ a schedule of all exceptions, including encumbrances and defects found in
the public records and any known unrecorded defects.
The premium for the policy is paid once, at closing. The maximum loss for which
the company may be liable cannot exceed the face amount of the policy (unless
the amount of coverage has been extended by use of an inflation rider).
Coverage Exactly which defects the title company will defend depends on the
type of policy (see Figure 8.4). A standard coverage policy normally insures the
title as it is known from the public records. In addition, the standard policy insures
against such hidden defects as forged documents, conveyances by incompetent
grantors, incorrect marital statements, and improperly delivered deeds.
FIGURE 8.4: Owner’s Title Insurance Policy
Standard Coverage
Extended Coverage
Not Covered by Either Policy
Defects found in public
records
Standard coverage plus
defects discoverable through
the following:
■■ Property inspection, including unrecorded rights of
persons in possession
■■ Examination of survey
■■ Unrecorded liens not
known by policyholder
Defects and liens listed in policy
Forged documents
Incompetent grantors
Incorrect marital
statements
Improperly delivered
deeds
Defects known to buyer
Changes in land use brought
about by zoning ordinances
Extended coverage as provided by an American Land Title Association (ALTA)
policy includes the protections of a standard policy plus additional protections.
An extended policy protects the homeowner against defects that may be discovered by inspection of the property: rights of parties in possession, examination of
a survey, and certain unrecorded liens.
Title insurance does not offer guaranteed protection against all defects. A title
company will not insure a bad title or offer protection against defects that clearly
appear in a title search. The policy generally names certain uninsurable losses,
called exclusions. These exclusions include zoning ordinances, restrictive covenants, easements,
certain
water
rights,
and current
taxes and
special assessments.
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of global copyright
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Types of Policies The different types of policies depend on who is named as
the insured. An owner’s policy is issued for the benefit of the owner (new buyer)
and the owner’s heirs or devisees. A lender’s policy is issued for the benefit of the
mortgage company. The amount of the coverage depends on the amount of the
mortgage loan.
SUMMARY
Title is ownership, or the right to ownership, of land and evidence of that
ownership.
Voluntary alienation is the voluntary transfer of title to real estate by gift or sale,
using some form of deed.
■■ Grantor (person who transfers title) must be of legal age and legally competent to execute (sign) a deed. A deed executed by a minor is voidable.
—— If the grantor has been declared incompetent by a judge, the deed is
void.
—— All names the grantor has used should be provided.
■■ Grantee must be identifiable with sufficient certainty.
■■ Consideration (payment) of some form must be stated.
■■ Granting clause (words of conveyance) must be used.
■■ Habendum clause must define ownership interest taken by the grantee; it
specifies limits on ownership, such as with a time-share.
■■ Legal description of the property conveyed is essential.
■■ Exceptions or reservations of any relevance must be included.
■■ Signature of the grantor(s) must be acknowledged by a notary public or
other official authorized by the state in which the property is located.
■■ Delivery of the deed and acceptance by the grantee are necessary.
Types of deeds include the following:
■■ General warranty deed provides the greatest protection to the grantee and
includes
—— covenant of seisin—warrants the grantor has the right to convey title;
—— covenant against encumbrances—warrants the property is free from liens
or encumbrances, unless expressly stated;
—— covenant of quiet enjoyment—makes the grantor liable for damages if
the grantee’s title is found to be inferior;
—— covenant of further assurance—the grantor’s promise to obtain any other
document necessary to convey good title; and
—— covenant of warranty forever—the grantor’s promise to compensate the
grantee if title fails at any future time.
■■ Special warranty deed includes the warranties that the grantor received title
and that the property was not encumbered during the time the grantor held
title, except as otherwise noted.
■■ Bargain and sale deed implies that the grantor holds title and possession of
the property, and there are no express warranties against encumbrances.
■■ Quitclaim deed provides the least protection of any deed, carries no covenants or warranties, and conveys only whatever interest the grantor may
have when the deed is delivered.
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Transfer tax stamps may be required to be affixed to deeds and conveyances before
being recorded, with the tax rate depending on state, county, and city requirements.
Involuntary alienation (transfer) of title to property is usually by operation of law.
■■ Escheat—property taken by state when the deceased has no heirs
■■ Eminent domain—property taken by public or government agency
■■ Foreclosure—property taken by creditor for nonpayment of debt secured by
real property
■■ Adverse possession—property seizure occurring when someone who is not
the lawful owner takes possession of property for the length of time specified
by state law, and usually in a way that is open, notorious, continuous, hostile,
and adverse.
Transfer of title by will occurs when the deceased dies testate, leaving a will prepared as required by state law. The following statements are true:
■■ Wills take effect only after death and can be changed by codicil or revoked
while the testator is still alive.
■■ Devise is a gift of real property by will to the devisee.
■■ Bequest is a gift of personal property.
■■ Legacy is a gift of money.
■■ To pass title to property on death, the will must be filed with the court and
probated.
■■ Wills cannot supersede state laws protecting inheritance rights of the surviving wife (dower) or husband (curtesy).
Transfer of title under a state’s statute of descent and distribution occurs when a
person dies intestate (without a will). Probate proceedings must have an administrator appointed, and laws of the state where the real property is located govern
property distribution.
Public records are typically searched by title companies that provide title insurance to prospective purchasers based on the findings of the title search.
Constructive notice of a document is assumed when due diligence (such as a
search of public records and inspection of the property) would reveal its existence.
Actual notice means that an individual has direct knowledge of documents in the
public records and facts revealed by an inspection of the property.
Unrecorded documents that may affect title, such as a tax lien, may not be
recorded immediately, yet are still given priority by law and require a search of tax
records and other sources.
Chain of title is a record of property ownership, but it does not include liens and
other encumbrances:
■■ A gap in the chain or other dispute of ownership creates a cloud on the title.
■■ A cloud on title is resolved by suit to quiet title.
An abstract of title, prepared by an abstractor or an attorney, is a summary report
of what the title search reveals. It includes all recorded liens and encumbrances
and lists records searched, but it does not indicate forgeries and interests that are
unrecorded or could be discovered by property inspection.
A marketable title is one that must
■■ not have serious defects, nor rely on doubtful questions of law or fact to
prove its validity;
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■■ not expose the purchaser to litigation nor threaten quiet enjoyment of prop-
erty; and
■■ convince a reasonably well-informed and prudent purchaser that the prop-
erty could be sold or mortgaged at a later time.
Proof of ownership may be established by certificate of title, but it will not reveal
unrecorded liens or rights of parties in possession.
Title insurance, issued as an owner’s or mortgagee’s (lender) policy under which
the insured is protected from losses arising from defects in title, insures against
hidden defects and identifies exclusions that include readily apparent title defects,
zoning, and others.
UNIT 8 REVIEW QUESTIONS
1. The grantee receives greatest protection with what type of deed?
a. Quitclaim
b. General warranty
c. Bargain and sale with covenant
d. Executor’s
2. Under the covenant of quiet enjoyment, the grantor
a. promises to obtain and deliver any instrument needed to make the title good.
b. guarantees to compensate the grantee if the title fails in the future.
c. warrants that he is the owner and has the right to convey title to the property.
d. ensures that the title will be good against the title claims of third parties.
3. Which type of deed merely implies but does NOT specifically warrant that the grantor holds good title to
the property?
a. Special warranty
b. Bargain and sale
c. Quitclaim
d. Trust deed
4. Eminent domain and escheat are two examples of
a. voluntary alienation.
b. adverse possession.
c. transfers of title by descent.
d. involuntary alienation.
5. A person who has died without a will has died
a. testate.
b. in valid conveyance.
c. intestate.
d. under the acknowledgment clause.
6. Generally, a probate proceeding involving real property takes place
a. only in the county in which the property is located.
b. only in the county in which the decedent resided.
c. in both the county where the decedent resided and the county in which the property is located.
d. in the county in which the executor or the beneficiary resides.
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7. Chain of title is MOST accurately defined as
a. a summary or history of all documents and legal proceedings affecting a specific parcel of land.
b. a report of the contents of the public record regarding a particular property.
c. an instrument or document that protects the insured parties (subject to specific exceptions) against
defects in the examination of the record and hidden risks such as forgeries, undisclosed heirs, errors in
the public records, and so forth.
d. a record of a property’s ownership.
8. A sells a portion of property to B. B promptly records the deed in the appropriate county office. If A tries to
sell the same portion of property to C, which statement is TRUE?
a. C has been given constructive notice of the prior sale because B promptly recorded the deed.
b. C has been given actual notice of the prior sale because B promptly recorded the deed.
c. Because C’s purchase of the property is the more recent, it will have priority over B’s interest, regardless
of when B recorded the deed.
d. Because C purchased the property from its rightful owner, C is presumed by law to be aware of B’s prior
interest.
9. Which of the following are traditionally covered by a standard title insurance policy?
a. Unrecorded rights of persons in possession
b. Improperly delivered deeds
c. Changes in land use due to zoning ordinances
d. Unrecorded liens not known to the policyholder
10. The mortgagee received a title insurance policy on the property a buyer is pledging as security for the mortgage loan. Which of the following is TRUE?
a. The policy is issued for the benefit of the buyer.
b. The policy guarantees that the buyer’s equity will be protected.
c. The amount of coverage is commensurate with the loan amount.
d. The amount of coverage increases as the borrower’s equity increases.
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9
U N I T
■■
LEARNING OBJECTIVES
Transaction Process and
Closing
When you have completed this unit, you will be able to
■■ describe the steps involved in the transaction process from contract to
closing;
■■ prepare a list of tasks to be done in preparation for closing by the closing
■■
■■
■■
■■
■■
■■
■■
agent;
list the tasks to be done by the buyer and the seller before closing;
describe a face-to-face closing, including where it might be held, individuals who attend, and any special considerations;
identify the items to be deposited by the seller and by the buyer in an
escrow closing;
discuss the impact of the Taxpayer Relief Act and the Consumer Protection Act on closings;
identify the practices that are prohibited by the Real Estate Settlement
Procedures Act;
define the disclosures required by the Real Estate Settlement Procedures
Act; and
identify items that are typically prorated at closing.
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KEY TERMS
affidavit of title
appraisal
assets
bring down
closing
closing agent
Closing Disclosure
computerized loan
origination (CLO)
controlled business
arrangement (CBA)
cost approach
credit
credit report
credit score
debit
depreciation
escrow or impound
account
escrow closing
exchange
face-to-face closing
flood insurance
home inspection
income approach
kickback
liabilities
Loan Estimate
market value
net worth
ownership and use tests
preapproval letter
prorations
Real Estate Settlement
Procedures Act
(RESPA)
sales comparison
approach
tri-merge credit report
underwriter
walk-through
zero tolerance
INTRODUCTION
The preparation of the sales contract, along with any contingencies, amendments,
or addenda, has been covered in earlier units. Once the contract has been ratified with the signatures of all parties, the transaction process begins. This period
between the ratification and the settlement, or closing, can take anywhere from a
few weeks to a few months, depending on the complexity of the contract or on the
personal wishes of the parties involved. In most cases, the closing involves both a
closing on the loan and the conveyance of title to the property.
TRANSACTION PROCESS
The Contract
After the offer to purchase and any subsequent contingencies or changes have
been agreed upon and signatures have been received from all parties, the offer
becomes a contract. Signed copies are returned to both buyer and seller and the
process begins.
The earnest money deposit that was received, along with the offer to purchase,
must now be deposited by either the listing broker or the selling broker, according
to state law. Unless otherwise agreed by the parties to the contract, the TREC
20-12 or another TREC-promulgated contract form is used. Under those contractual documents, the buyer, not the licensee, is required to deposit the money
with the escrow agent (usually a title company) after the contract is formed and
executed by both seller and buyer. If the broker is in receipt of the earnest money,
the Rules of the Real Estate Commission say it must be deposited with the escrow
agent by the close of business on the second working day after the contract is fully
executed. A broker maintaining a trust account must retain for four years a documentary record of each deposit or withdrawal from the account.
In some cases, the earnest money deposit (EMD) may earn interest. The financing
contingency protects the purchaser, for a limited amount of time, from losing the
earnest money in case the contract falls through due to an inability of the buyer
to obtainorfinancing.
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resale of this product is in direct violation of global copyright laws.
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TX_Law_Contracts_2EU_v2.5_book.indb 176
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Unit 9 Transaction Process and Closing
177
A copy of the contract is sent to the closing agent or title company, as stated in
the contract, so that title work can be started.
LOAN APPROVAL
A preapproval letter from the lender stating that the borrower is approved for
a real estate loan up to a specified amount may have been submitted along with
the original offer to purchase. In any case, now that a specific property has been
selected, the borrower is ready to make a formal loan application. See Figure 9.1
for the Uniform Residential Loan Application form used by most lenders. The
application form lists all assets and liabilities of the borrower in order to determine the applicant’s net worth.
The lender must provide the borrower with a Loan Estimate of all closing costs
involved in obtaining and settling on a mortgage loan within three days of application. See Figure 9.2 for a sample Loan Estimate. A Closing Disclosure must be
delivered to the purchaser at least three days before closing.
Credit Report The loan officer orders a credit report (if one is not already on
file) and an appraisal. A processor opens a case file that will carry all documentation and reports from this point until closing. In addition to the credit report,
verifications of income, employment, and deposits are usually required.
In most cases, a tri-merge credit report containing credit information and credit
scores from all three major credit reporting agencies is ordered. When the scores
are different, the middle one is usually used. An assessment of the information is
made to determine the prospective borrower’s financial ability and attitude toward
meeting financial obligations. The credit score (often called the FICO score after
the company that originated the scoring system) is based on the borrower’s history
of payment (35%), the amount owed (30%), the length of credit history (15%),
and new credit (10%), as well as other factors, such as the number of credit cards,
percentage of credit used, or maxed-out cards (10%). An acceptable credit score
may vary depending on the loan program being applied for or the amount of down
payment.
An application for a commercial or industrial loan requires much more information than that for a residence. A Dun and Bradstreet, Inc. report, as well as audited
financial and profit-and-loss statements for both current and previous years, may
be required.
Appraisal Most lenders have an established loan-to-value ratio (LTV) established for each of their loan programs. An appraisal is needed to ensure that the
property being used as collateral for the loan is adequate for a recovery of their
investment in case of default. If the appraisal is less than the sales price, the LTV
may not be met, and the contract may have to be renegotiated.
Lenders can choose an appraiser from either a rotating roster or from a preapproved list. The Federal Housing Finance Agency has issued appraisal standards to
improve the quality and consistency of appraisals for mortgages to be sold to Fannie Mae and Freddie Mac. See Figure 9.3 for the Uniform Residential Appraisal
Report that is required for most loans.
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TX_Law_Contracts_2EU_v2.5_book.indb 177
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FIGURE 9.1: Uniform Residential Loan Application
8QLIRUP5HVLGHQWLDO/RDQ$SSOLFDWLRQ
___________________________________________________________________________________________________________________________________________________________________
This application is designed to be completed by the applicant(s) with the Lender’s assistance. Applicants should complete this form as “Borrower” or “Co-Borrower,” as applicable. Co-Borrower
information must also be provided (and the appropriate box checked) when † the income or assets of a person other than the Borrower (including the Borrower’s spouse) will be used as a basis for loan
qualification or † the income or assets of the Borrower’s spouse or other person who has community property rights pursuant to state law will not be used as a basis for loan qualification, but his or her
liabilities must be considered because the spouse or other person has community property rights pursuant to applicable law and Borrower resides in a community property state, the security property is
located in a community property state, or the Borrower is relying on other property located in a community property state as a basis for repayment of the loan.
If this is an application for joint credit, Borrower and Co-Borrower each agree that we intend to apply for joint credit (sign below):
_________________________________________
_________________________________________
Borrower
Co-Borrower
,7<3(2)0257*$*($1'7(5062)/2$1
0RUWJDJH
$SSOLHGIRU
† VA
† FHA
† Conventional
† USDA/Rural
Housing Service
Amount
$
Interest Rate
† Other (explain):
Agency Case Number
$PRUWL]DWLRQ7\SH
No. of Months
%
† Fixed Rate
† GPM
Lender Case Number
† Other (explain):
† ARM (type):
,,3523(57<,1)250$7,21$1'385326(2)/2$1
Subject Property Address (street, city, state & ZIP)
No. of Units
Legal Description of Subject Property (attach description if necessary)
Year Built
† Purchase
† Refinance
Purpose of Loan
† Construction
† Other (explain):
† Construction-Permanent
Property will be:
† Primary Residence
† Secondary Residence
† Investment
Complete this line if construction or construction-permanent loan.
Year Lot
Acquired
Original Cost
Amount Existing Liens
(a) Present Value of Lot
(b) Cost of Improvements
Total (a + b)
$
$
$
$
$
Complete this line if this is a refinance loan.
Year
Acquired
Original Cost
Amount Existing Liens
$
$
Purpose of Refinance
† made
Describe Improvements
† to be made
Cost: $
Title will be held in what Name(s)
Manner in which Title will be held
Estate will be held in:
† Fee Simple
† Leasehold (show
expiration date)
Source of Down Payment, Settlement Charges, and/or Subordinate Financing (explain)
%RUURZHU
,,,%2552:(5,1)250$7,21
Borrower’s Name (include Jr. or Sr. if applicable)
Social Security Number
† Married
† Separated
Home Phone
(incl. area code)
† Unmarried (include
single, divorced, widowed)
DOB (mm/dd/yyyy)
Yrs. School
Social Security Number
Home Phone
(incl. area code)
† Married
† Unmarried (include
† Separated
single, divorced, widowed)
Dependents (not listed by Co-Borrower)
no.
ages
† Own
Present Address (street, city, state, ZIP)
&R%RUURZHU
Co-Borrower’s Name (include Jr. or Sr. if applicable)
† Rent ____No. Yrs.
Yrs. School
Dependents (not listed by Borrower)
no.
Present Address (street, city, state, ZIP)
Mailing Address, if different from Present Address
DOB (mm/dd/yyyy)
ages
† Own
† Rent ____No. Yrs.
† Own
† Rent ____No. Yrs.
Mailing Address, if different from Present Address
If residing at present address for less than two years, complete the following:
Former Address (street, city, state, ZIP)
† Own
† Rent ____No. Yrs.
%RUURZHU
,9(03/2<0(17,1)250$7,21
† Self Employed
Name & Address of Employer
Former Address (street, city, state, ZIP)
Yrs. on this job
Name & Address of Employer
Yrs. employed in this
line of work/profession
Position/Title/Type of Business
Business Phone (incl. area code)
&R%RUURZHU
† Self Employed
Yrs. on this job
Yrs. employed in this
line of work/profession
Position/Title/Type of Business
Business Phone (incl. area code)
If employed in current position for less than two years or if currently employed in more than one position, complete the following:
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Customized for use solely by CE Souce.
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179
Unit 9 Transaction Process and Closing
FIGURE 9.1: Uniform Residential Loan Application (continued)
%RUURZHU
,9(03/2<0(17,1)250$7,21FRQW¶G
† Self Employed
Name & Address of Employer
Dates (from – to)
&R%RUURZHU
† Self Employed
Name & Address of Employer
Dates (from – to)
Monthly Income
Monthly Income
$
Position/Title/Type of Business
$
Business Phone
(incl. area code)
† Self Employed
Name & Address of Employer
Position/Title/Type of Business
Business Phone
(incl. area code)
† Self Employed
Name & Address of Employer
Dates (from – to)
Dates (from – to)
Monthly Income
Monthly Income
$
Position/Title/Type of Business
$
Business Phone
(incl. area code)
Position/Title/Type of Business
Business Phone
(incl. area code)
90217+/<,1&20($1'&20%,1('+286,1*(;3(16(,1)250$7,21
*URVV
0RQWKO\,QFRPH
Base Empl. Income*
%RUURZHU
$
7RWDO
&R%RUURZHU
$
$
&RPELQHG0RQWKO\
+RXVLQJ([SHQVH
Rent
Overtime
First Mortgage (P&I)
Bonuses
Other Financing (P&I)
Commissions
Hazard Insurance
Real Estate Taxes
Mortgage Insurance
Other (before completing,
Homeowner Assn. Dues
Other:
$
3URSRVHG
$
Net Rental Income
see the notice in “describe
other income,” below)
3UHVHQW
$
Dividends/Interest
7RWDO
$
7RWDO
$
$
$
6HOI(PSOR\HG%RUURZHUVPD\EHUHTXLUHGWRSURYLGHDGGLWLRQDOGRFXPHQWDWLRQVXFKDVWD[UHWXUQVDQGILQDQFLDOVWDWHPHQWV
Notice: $OLPRQ\FKLOGVXSSRUWRUVHSDUDWHPDLQWHQDQFHLQFRPHQHHGQRWEHUHYHDOHG
LIWKH%RUURZHU%RU&R%RUURZHU&GRHVQRWFKRRVHWRKDYHLWFRQVLGHUHG
IRUUHSD\LQJWKLVORDQ
'HVFULEH2WKHU,QFRPH
B/C
Monthly Amount
$
9,$66(76$1'/,$%,/,7,(6
This Statement and any applicable supporting schedules may be completed jointly by both married and unmarried Co-Borrowers if their assets and liabilities are sufficiently joined so that the Statement
can be meaningfully and fairly presented on a combined basis; otherwise, separate Statements and Schedules are required. If the Co-Borrower section was completed about a non-applicant spouse or other
person, this Statement and supporting schedules must be completed about that spouse or other person also.
Completed † Jointly † Not Jointly
&DVKRU
0DUNHW9DOXH
$66(76
Description
Cash deposit toward
purchase held by:
$
/LDELOLWLHVDQG3OHGJHG$VVHWV List the creditor’s name, address, and account number for all outstanding debts, including
automobile loans, revolving charge accounts, real estate loans, alimony, child support, stock pledges, etc. Use
continuation sheet, if necessary. Indicate by (*) those liabilities, which will be satisfied upon sale of real estate owned or
upon refinancing of the subject property.
/,$%,/,7,(6
List checking and savings accounts below
Name and address of Bank, S&L, or Credit Union
Name and address of Company
Acct. no.
Acct. no.
$
Name and address of Bank, S&L, or Credit Union
Acct. no.
$
Name and address of Company
Name and address of Company
Acct. no.
Acct. no.
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)UHGGLH0DF)RUPUHY
8QSDLG%DODQFH
$ Payment/Months
$
$ Payment/Months
$
$ Payment/Months
$
Acct. no.
Name and address of Bank, S&L, or Credit Union
$
0RQWKO\3D\PHQW
0RQWKV/HIWWR3D\
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FIGURE 9.1: Uniform Residential Loan Application (continued)
9,$66(76$1'/,$%,/,7,(6FRQW¶G
Name and address of Bank, S&L, or Credit Union
Name and address of Company
$ Payment/Months
$
Acct. no.
$
Acct. no.
Stocks & Bonds (Company name/
number & description)
$
Name and address of Company
$ Payment/Months
$
Life insurance net cash value
$
Acct. no.
Name and address of Company
$ Payment/Months
$
Face amount: $
6XEWRWDO/LTXLG$VVHWV
$
Real estate owned (enter market value
from schedule of real estate owned)
Vested interest in retirement fund
$
Net worth of business(es) owned
(attach financial statement)
$
Automobiles owned (make
and year)
$
Other Assets (itemize)
$
7RWDO$VVHWVD
$
Acct. no.
Alimony/Child Support/Separate
Maintenance Payments Owed to:
$
$
Job-Related Expense (child care, union dues, etc.)
$
7RWDO0RQWKO\3D\PHQWV
Net Worth
(a minus b)
Ź
7RWDO/LDELOLWLHVE
$
$
6FKHGXOHRI5HDO(VWDWH2ZQHG (If additional properties are owned, use continuation sheet.)
Property Address (enter S if sold, PS if pending sale or R
if rental being held for income)
ź
Type of
Property
Amount
of Mortgages
& Liens
Present
Market Value
$
$
$
$
Totals
$
$
$
$
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Alternate Name
Creditor Name
9,,'(7$,/62)75$16$&7,21
$
Insurance,
Maintenance,
Taxes & Misc.
Mortgage
Payments
Gross
Rental Income
Net Rental
Income
$
$
$
$
Account Number
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a.
Purchase price
b.
Alterations, improvements, repairs
a. Are there any outstanding judgments against you?
††
††
c.
Land (if acquired separately)
b. Have you been declared bankrupt within the past 7 years?
††
††
d.
Refinance (incl. debts to be paid off)
††
††
e.
Estimated prepaid items
c. Have you had property foreclosed upon or given title
or deed in lieu thereof in the last 7 years?
d. Are you a party to a lawsuit?
††
††
f.
Estimated closing costs
††
††
g.
PMI, MIP, Funding Fee
h.
Discount (if Borrower will pay)
i.
Total costs (add items a through h)
e. Have you directly or indirectly been obligated on any
loan which resulted in foreclosure, transfer of title
in lieu of foreclosure, or judgment?
(This would include such loans as home mortgage loans, SBA loans, home
improvement loans, educational loans, manufactured (mobile) home loans, any
mortgage, financial obligation, bond, or loan guarantee. If “Yes,” provide
details, including date, name, and address of Lender, FHA or VA case number,
if any, and reasons for the action.)
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TX_Law_Contracts_2EU_v2.5_book.indb 180
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Unit 9 Transaction Process and Closing
FIGURE 9.1: Uniform Residential Loan Application (continued)
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TX_Law_Contracts_2EU_v2.5_book.indb 181
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182
Texas Law of Contracts Second Edition Update
FIGURE 9.1: Uniform Residential Loan Application (continued)
&217,18$7,216+((75(6,'(17,$//2$1$33/,&$7,21
Use this continuation sheet if you need more
space to complete the Residential Loan
Application. Mark %f or Borrower or &for
Co-Borrower.
Borrower:
Agency Case Number:
Co-Borrower:
Lender Case Number:
______________________________________________________________________________________________________________________________________________
I/We fully understand that it is a Federal crime punishable by fine or imprisonment, or both, to knowingly make any false statements concerning any of the above facts as applicable under the provisions
of Title 18, United States Code, Section 1001, et seq.
Borrower’s Signature
Date
Co-Borrower’s Signature
Date
;
;
8QLIRUP5HVLGHQWLDO/RDQ$SSOLFDWLRQ
)UHGGLH0DF)RUPUHY3DJHRI
)DQQLH0DH)RUPUHY
Unauthorized reproduction or resale of this product is in direct violation of global copyright laws.
Customized for use solely by CE Souce.
TX_Law_Contracts_2EU_v2.5_book.indb 182
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Unit 9 Transaction Process and Closing
183
FIGURE 9.2: Sample Loan Estimate
FICUS BANK
Save this Loan Estimate to compare with your Closing Disclosure.
4321 Random Boulevard • Somecity, ST 12340
Loan Estimate
DATE ISSUED
APPLICANTS
PROPERTY
SALE PRICE
LOAN TERM
PURPOSE
2/15/2013
Michael Jones and Mary Stone
123 Anywhere Street
Anytown, ST 12345
456 Somewhere Avenue
Anytown, ST 12345
$180,000
PRODUCT
LOAN TYPE
LOAN ID #
RATE LOCK
30 years
Purchase ce
Fixed Rate
x Conventional
FHA VA
_____________
1234567891330172608
NO x YES, until 4/16/2013 at 5:00 p.m. EDT
Before closing, your interest rate, points, and lender credits can
change unless you lock the interest rate. All other estimated
closing costs expire on 3/4/2013 at 5:00 p.m. EDT
Loan Terms
Can this amount increase after closing?
Loan Amount
$162,000
NO
Interest Rate
3.875%
NO
Monthly Principal & Interest
$761.78
NO
See Projected Payments below for your
Estimated Total Monthly Payment
Does the loan have these features?
Prepayment Penalty
YES
Balloon Payment
NO
• As high as $3,240 if you pay off the loan during the
first 2 years
Projected Payments
Payment Calculation
Years 1-7
Years 8-30
Principal & Interest
$761.78
$761.78
Mortgage Insurance
+
82
+
—
Estimated Escrow
+
206
+
206
Amount can increase over time
Estimated Total
Monthly Payment
Estimated Taxes, Insurance
& Assessments
Amount can increase over time
$1,050
$206
a month
This estimate includes
x Property Taxes
x Homeowner’s Insurance
Other:
$968
In escrow?
YES
YES
See Section G on page 2 for escrowed property costs. You must pay for other
property costs separately.
Costs at Closing
Estimated Closing Costs
$8,054
Includes $5,672 in Loan Costs + $2,382 in Other Costs – $0
in Lender Credits. See page 2 for details.
Estimated Cash to Close
$16,054
Includes Closing Costs. See Calculating Cash to Close on page 2 for details.
Visit www.consumerfinance.gov/mortgage-estimate for general information and tools.
LOAN ESTIMATE
PAGE 1 OF 3 • LOAN ID # 123456789
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Customized for use solely by CE Souce.
TX_Law_Contracts_2EU_v2.5_book.indb 183
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184
Texas Law of Contracts Second Edition Update
FIGURE 9.2: Sample Loan Estimate (continued)
Closing Cost Details
Loan Costs
Other Costs
A. Origination Charges
.25 % of Loan Amount (Points)
Application Fee
Underwriting Fee
B. Services You Cannot Shop For
Appraisal Fee
Credit Report Fee
Flood Determination Fee
Flood Monitoring Fee
Tax Monitoring Fee
Tax Status Research Fee
C. Services You Can Shop For
Pest Inspection Fee
Survey Fee
Title – Insurance Binder
Title – Lender’s Title Policy
Title – Settlement Agent Fee
Title – Title Search
$1,802
$405
$300
$1,097
$672
$405
$30
$20
$32
$75
$110
$3,198
$135
$65
$700
$535
$502
$1,261
E. Taxes and Other Government Fees
Recording Fees and Other Taxes
Transfer Taxes
F. Prepaids
Homeowner’s Insurance Premium ( 6 months)
Mortgage Insurance Premium ( months)
Prepaid Interest ( $17.44 per day for 15 days @ 3.875%)
Property Taxes ( months)
$867
$605
G. Initial Escrow Payment at Closing
Homeowner’s Insurance $100.83 per month for 23mo.
Mortgage Insurance
per month for 0 mo.
Property Taxes
$105.30 per month for 2 mo.
$413
$202
I. TOTAL OTHER COSTS (E + F + G + H)
$2,382
J. TOTAL CLOSING COSTS
$8,054
D+I
Lender Credits
$8,054
Calculating Cash to Close
Total Closing Costs (J)
$8,054
Deposit
LOAN ESTIMATE
$211
$1,017
$1,017
Down Payment/Funds from Borrower
$5,672
$262
H. Other
Title – Owner’s Title Policy (optional)
Closing Costs Financed (Paid from your Loan Amount)
D. TOTAL LOAN COSTS (A + B + C)
$85
$85
$0
$18,000
– $10,000
Funds for Borrower
$0
Seller Credits
$0
Adjustments and Other Credits
$0
Estimated Cash to Close
$16,054
PAGE 2 OF 3 • LOAN ID # 123456789
Unauthorized reproduction or resale of this product is in direct violation of global copyright laws.
Customized for use solely by CE Souce.
TX_Law_Contracts_2EU_v2.5_book.indb 184
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185
Unit 9 Transaction Process and Closing
FIGURE 9.2: Sample Loan Estimate (continued)
Additional Information About This Loan
Ficus Bank
LENDER
NMLS/__ LICENSE ID
LOAN OFFICER
NMLS/__ LICENSE ID
Joe Smith
12345
[email protected]
123-456-7890
EMAIL
PHONE
Comparisons
MORTGAGE BROKER
NMLS/__ LICENSE ID
LOAN OFFICER
NMLS/__ LICENSE ID
EMAIL
PHONE
Use these measures to compare this loan with other loans.
In 5 Years
$56,582
$15,773
Total you will have paid in principal, interest, mortgage insurance, and loan costs.
Annual Percentage Rate (APR)
4.274%
Your costs over the loan term expressed as a rate. This is not your interest rate.
Total Interest Percentage (TIP)
69.45%
The total amount of interest that you will pay over the loan term as a
percentage of your loan amount.
Principal you will have paid off.
Other Considerations
Appraisal
We may order an appraisal to determine the property’s value and charge you for this
appraisal. We will promptly give you a copy of any appraisal, even if your loan does not close.
You can pay for an additional appraisal for your own use at your own cost.
Assumption
If you sell or transfer this property to another person, we
will allow, under certain conditions, this person to assume this loan on the original terms.
x will not allow assumption of this loan on the original terms.
Homeowner’s
Insurance
This loan requires homeowner’s insurance on the property, which you may obtain from a
company of your choice that we find acceptable.
Late Payment
If your payment is more than 15 days late, we will charge a late fee of 5% of the monthly
principal and interest payment.
Refinance
Refinancing this loan will depend on your future financial situation, the property value, and
market conditions. You may not be able to refinance this loan.
Servicing
We intend
to service your loan. If so, you will make your payments to us.
x to transfer servicing of your loan.
Confirm Receipt
By signing, you are only confirming that you have received this form. You do not have to accept this loan because you have signed or
received this form.
Applicant Signature
Date
LOAN ESTIMATE
Co-Applicant Signature
Date
PAGE 3 OF 3 • LOAN ID #123456789
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TX_Law_Contracts_2EU_v2.5_book.indb 185
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186
Texas Law of Contracts Second Edition Update
FIGURE 9.3: Uniform Residential Appraisal Report
Uniform Residential Appraisal Report
File #
The purpose of this summary appraisal report is to provide the lender/client with an accurate, and adequately supported, opinion of the market value of the subject property.
Property Address
City
State
Zip Code
Borrower
Owner of Public Record
County
Legal Description
Tax Year
R.E. Taxes $
S Assessor’s Parcel #
U
Neighborhood Name
Map Reference
Census Tract
B
J Occupant
Owner
Tenant
Vacant
Special Assessments $
PUD
HOA $
per year
per month
E
Property Rights Appraised
Fee Simple
Leasehold
Other (describe)
C
T Assignment Type
Purchase Transaction
Refinance Transaction
Other (describe)
Lender/Client
Address
Is the subject property currently offered for sale or has it been offered for sale in the twelve months prior to the effective date of this appraisal?
Yes
No
Report data source(s) used, offering price(s), and date(s).
C
O
N
T
R
A
C
T
N
E
I
G
H
B
O
R
H
O
O
D
I
did
did not analyze the contract for sale for the subject purchase transaction. Explain the results of the analysis of the contract for sale or why the analysis was not
performed.
Contract Price $
Date of Contract
Is the property seller the owner of public record?
Yes
No Data Source(s)
Is there any financial assistance (loan charges, sale concessions, gift or downpayment assistance, etc.) to be paid by any party on behalf of the borrower?
If Yes, report the total dollar amount and describe the items to be paid.
Note: Race and the racial composition of the neighborhood are not appraisal factors.
Neighborhood Characteristics
One-Unit Housing Trends
Location
Urban
Suburban
Rural
Property Values
Increasing
Stable
Built-Up
Over 75%
25–75%
Under 25% Demand/Supply
Shortage
In Balance
Growth
Rapid
Stable
Slow
Marketing Time
Under 3 mths
3–6 mths
Neighborhood Boundaries
Declining
Over Supply
Over 6 mths
Neighborhood Description
One-Unit Housing
PRICE
AGE
$ (000)
(yrs)
Low
High
Pred.
I
M
P
R
O
V
E
M
E
N
T
S
No
Present Land Use %
One-Unit
%
2-4 Unit
%
Multi-Family
%
Commercial
%
Other
%
Market Conditions (including support for the above conclusions)
Dimensions
Area
Shape
Specific Zoning Classification
Zoning Description
Zoning Compliance
Legal
Legal Nonconforming (Grandfathered Use)
No Zoning
Illegal (describe)
Is the highest and best use of the subject property as improved (or as proposed per plans and specifications) the present use?
S
I
T
E
Yes
View
Yes
No If No, describe
Utilities
Public Other (describe)
Public Other (describe)
Off-site Improvements—Type
Public Private
Electricity
Water
Street
Gas
Sanitary Sewer
Alley
FEMA Special Flood Hazard Area
Yes
No FEMA Flood Zone
FEMA Map #
FEMA Map Date
Are the utilities and off-site improvements typical for the market area?
Yes
No If No, describe
Are there any adverse site conditions or external factors (easements, encroachments, environmental conditions, land uses, etc.)?
Yes
No If Yes, describe
General Description
Foundation
Exterior Description
materials/condition Interior
materials/condition
Units
One
One with Accessory Unit
Concrete Slab
Crawl Space
Foundation Walls
Floors
# of Stories
Full Basement
Partial Basement Exterior Walls
Walls
Type
Det.
Att.
S-Det./End Unit Basement Area
sq. ft. Roof Surface
Trim/Finish
Existing
Proposed
Under Const. Basement Finish
% Gutters & Downspouts
Bath Floor
Design (Style)
Outside Entry/Exit
Sump Pump
Window Type
Bath Wainscot
Year Built
Evidence of
Infestation
Storm Sash/Insulated
Car Storage
None
Effective Age (Yrs)
Dampness
Settlement
Screens
Driveway # of Cars
Attic
None
Heating
FWA
HWBB
Radiant Amenities
Woodstove(s) #
Driveway Surface
Drop Stair
Stairs
Other
Fuel
Fireplace(s) #
Fence
Garage
# of Cars
Floor
Scuttle
Cooling
Central Air Conditioning
Patio/Deck
Porch
Carport
# of Cars
Finished
Heated
Individual
Other
Pool
Other
Att.
Det.
Built-in
Appliances
Refrigerator
Range/Oven
Dishwasher
Disposal
Microwave
Washer/Dryer
Other (describe)
Finished area above grade contains:
Rooms
Bedrooms
Bath(s)
Square Feet of Gross Living Area Above Grade
Additional features (special energy efficient items, etc.)
Describe the condition of the property (including needed repairs, deterioration, renovations, remodeling, etc.).
Are there any physical deficiencies or adverse conditions that affect the livability, soundness, or structural integrity of the property?
Does the property generally conform to the neighborhood (functional utility, style, condition, use, construction, etc.)?
Freddie Mac Form 70 March 2005
Page 1 of 6
Yes
Yes
No If Yes, describe
No If No, describe
Fannie Mae Form 1004 March 2005
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TX_Law_Contracts_2EU_v2.5_book.indb 186
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187
Unit 9 Transaction Process and Closing
FIGURE 9.3: Uniform Residential Appraisal Report (continued)
Uniform Residential Appraisal Report
File #
There are
comparable properties currently offered for sale in the subject neighborhood ranging in price from $
There are
comparable sales in the subject neighborhood within the past twelve months ranging in sale price from $
FEATURE
SUBJECT
COMPARABLE SALE # 1
COMPARABLE SALE # 2
Address
S
A
L
E
S
C
O
M
P
A
R
I
S
O
N
A
P
P
R
O
A
C
H
Proximity to Subject
Sale Price
$
$
Sale Price/Gross Liv. Area $
sq. ft. $
sq. ft.
Data Source(s)
Verification Source(s)
VALUE ADJUSTMENTS
DESCRIPTION
DESCRIPTION
+(-) $ Adjustment
Sale or Financing
Concessions
Date of Sale/Time
Location
Leasehold/Fee Simple
Site
View
Design (Style)
Quality of Construction
Actual Age
Condition
Total Bdrms. Baths Total Bdrms. Baths
Above Grade
Room Count
Gross Living Area
sq. ft.
sq. ft.
Basement & Finished
Rooms Below Grade
Functional Utility
Heating/Cooling
Energy Efficient Items
Garage/Carport
Porch/Patio/Deck
$
sq. ft.
DESCRIPTION
Total
$
sq. ft.
DESCRIPTION
Total
$
+(-) $ Adjustment
Bdrms. Baths
sq. ft.
Net Adjustment (Total)
+
$
+
$
Adjusted Sale Price
Net Adj.
%
Net Adj.
%
of Comparables
Gross Adj.
% $
Gross Adj.
% $
I
did
did not research the sale or transfer history of the subject property and comparable sales. If not, explain
.
.
to $
COMPARABLE SALE # 3
$
+(-) $ Adjustment
Bdrms. Baths
to $
sq. ft.
+
Net Adj.
Gross Adj.
-
$
%
% $
My research
did
did not reveal any prior sales or transfers of the subject property for the three years prior to the effective date of this appraisal.
Data source(s)
My research
did
did not reveal any prior sales or transfers of the comparable sales for the year prior to the date of sale of the comparable sale.
Data source(s)
Report the results of the research and analysis of the prior sale or transfer history of the subject property and comparable sales (report additional prior sales on page 3).
ITEM
SUBJECT
COMPARABLE SALE # 1
COMPARABLE SALE # 2
COMPARABLE SALE # 3
Date of Prior Sale/Transfer
Price of Prior Sale/Transfer
Data Source(s)
Effective Date of Data Source(s)
Analysis of prior sale or transfer history of the subject property and comparable sales
Summary of Sales Comparison Approach
R
E
C
O
N
C
I
L
I
A
T
I
O
N
Indicated Value by Sales Comparison Approach $
Indicated Value by: Sales Comparison Approach $
Cost Approach (if developed) $
Income Approach (if developed) $
This appraisal is made
“as is”,
subject to completion per plans and specifications on the basis of a hypothetical condition that the improvements have been
completed,
subject to the following repairs or alterations on the basis of a hypothetical condition that the repairs or alterations have been completed, or
subject to the
following required inspection based on the extraordinary assumption that the condition or deficiency does not require alteration or repair:
Based on a complete visual inspection of the interior and exterior areas of the subject property, defined scope of work, statement of assumptions and limiting
conditions, and appraiser’s certification, my (our) opinion of the market value, as defined, of the real property that is the subject of this report is
$
, as of
, which is the date of inspection and the effective date of this appraisal.
Freddie Mac Form 70 March 2005
Page 2 of 6
Fannie Mae Form 1004 March 2005
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TX_Law_Contracts_2EU_v2.5_book.indb 187
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Texas Law of Contracts Second Edition Update
FIGURE 9.3: Uniform Residential Appraisal Report (continued)
Uniform Residential Appraisal Report
File #
A
D
D
I
T
I
O
N
A
L
C
O
M
M
E
N
T
S
COST APPROACH TO VALUE (not required by Fannie Mae)
Provide adequate information for the lender/client to replicate the below cost figures and calculations.
Support for the opinion of site value (summary of comparable land sales or other methods for estimating site value)
C
O
S
T
A
P
P
R
O
A
C
H
ESTIMATED
REPRODUCTION OR
REPLACEMENT COST NEW
Source of cost data
Quality rating from cost service
Effective date of cost data
Comments on Cost Approach (gross living area calculations, depreciation, etc.)
Garage/Carport
Sq. Ft. @ $
..................... =$
Total Estimate of Cost-New
.................... = $
Less
Physical
Functional
External
Depreciation
=$(
Depreciated Cost of Improvements...................................................... =$
“As-is” Value of Site Improvements...................................................... =$
Estimated Remaining Economic Life (HUD and VA only)
I
N
C
O
M
E
OPINION OF SITE VALUE ................................................................. = $
Dwelling
Sq. Ft. @ $
..................... =$
Sq. Ft. @ $
..................... =$
)
Years Indicated Value By Cost Approach ...................................................... =$
INCOME APPROACH TO VALUE (not required by Fannie Mae)
Estimated Monthly Market Rent $
X Gross Rent Multiplier
Summary of Income Approach (including support for market rent and GRM)
= $
Indicated Value by Income Approach
PROJECT INFORMATION FOR PUDs (if applicable)
P
U
D
I
N
F
O
R
M
A
T
I
O
N
Is the developer/builder in control of the Homeowners’ Association (HOA)?
Yes
No Unit type(s)
Detached
Attached
Provide the following information for PUDs ONLY if the developer/builder is in control of the HOA and the subject property is an attached dwelling unit.
Legal name of project
Total number of phases
Total number of units
Total number of units sold
Total number of units rented
Total number of units for sale
Data source(s)
Was the project created by the conversion of an existing building(s) into a PUD?
Yes
No If Yes, date of conversion
Does the project contain any multi-dwelling units?
Yes
No Data source(s)
Are the units, common elements, and recreation facilities complete?
Yes
No If No, describe the status of completion.
Are the common elements leased to or by the Homeowners’ Association?
Yes
No If Yes, describe the rental terms and options.
Describe common elements and recreational facilities
Freddie Mac Form 70 March 2005
Page 3 of 6
Fannie Mae Form 1004 March 2005
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Unit 9 Transaction Process and Closing
FIGURE 9.3: Uniform Residential Appraisal Report (continued)
Uniform Residential Appraisal Report
File #
This report form is designed to report an appraisal of a one-unit property or a one-unit property with an accessory unit;
including a unit in a planned unit development (PUD). This report form is not designed to report an appraisal of a
manufactured home or a unit in a condominium or cooperative project.
This appraisal report is subject to the following scope of work, intended use, intended user, definition of market value,
statement of assumptions and limiting conditions, and certifications. Modifications, additions, or deletions to the intended
use, intended user, definition of market value, or assumptions and limiting conditions are not permitted. The appraiser may
expand the scope of work to include any additional research or analysis necessary based on the complexity of this appraisal
assignment. Modifications or deletions to the certifications are also not permitted. However, additional certifications that do
not constitute material alterations to this appraisal report, such as those required by law or those related to the appraiser’s
continuing education or membership in an appraisal organization, are permitted.
SCOPE OF WORK: The scope of work for this appraisal is defined by the complexity of this appraisal assignment and the
reporting requirements of this appraisal report form, including the following definition of market value, statement of
assumptions and limiting conditions, and certifications. The appraiser must, at a minimum: (1) perform a complete visual
inspection of the interior and exterior areas of the subject property, (2) inspect the neighborhood, (3) inspect each of the
comparable sales from at least the street, (4) research, verify, and analyze data from reliable public and/or private sources,
and (5) report his or her analysis, opinions, and conclusions in this appraisal report.
INTENDED USE: The intended use of this appraisal report is for the lender/client to evaluate the property that is the
subject of this appraisal for a mortgage finance transaction.
INTENDED USER: The intended user of this appraisal report is the lender/client.
DEFINITION OF MARKET VALUE: The most probable price which a property should bring in a competitive and open
market under all conditions requisite to a fair sale, the buyer and seller, each acting prudently, knowledgeably and assuming
the price is not affected by undue stimulus. Implicit in this definition is the consummation of a sale as of a specified date and
the passing of title from seller to buyer under conditions whereby: (1) buyer and seller are typically motivated; (2) both
parties are well informed or well advised, and each acting in what he or she considers his or her own best interest; (3) a
reasonable time is allowed for exposure in the open market; (4) payment is made in terms of cash in U. S. dollars or in terms
of financial arrangements comparable thereto; and (5) the price represents the normal consideration for the property sold
unaffected by special or creative financing or sales concessions* granted by anyone associated with the sale.
*Adjustments to the comparables must be made for special or creative financing or sales concessions. No adjustments are
necessary for those costs which are normally paid by sellers as a result of tradition or law in a market area; these costs are
readily identifiable since the seller pays these costs in virtually all sales transactions. Special or creative financing
adjustments can be made to the comparable property by comparisons to financing terms offered by a third party institutional
lender that is not already involved in the property or transaction. Any adjustment should not be calculated on a mechanical
dollar for dollar cost of the financing or concession but the dollar amount of any adjustment should approximate the market’s
reaction to the financing or concessions based on the appraiser’s judgment.
STATEMENT OF ASSUMPTIONS AND LIMITING CONDITIONS: The appraiser’s certification in this report is
subject to the following assumptions and limiting conditions:
1. The appraiser will not be responsible for matters of a legal nature that affect either the property being appraised or the title
to it, except for information that he or she became aware of during the research involved in performing this appraisal. The
appraiser assumes that the title is good and marketable and will not render any opinions about the title.
2. The appraiser has provided a sketch in this appraisal report to show the approximate dimensions of the improvements.
The sketch is included only to assist the reader in visualizing the property and understanding the appraiser’s determination
of its size.
3. The appraiser has examined the available flood maps that are provided by the Federal Emergency Management Agency
(or other data sources) and has noted in this appraisal report whether any portion of the subject site is located in an
identified Special Flood Hazard Area. Because the appraiser is not a surveyor, he or she makes no guarantees, express or
implied, regarding this determination.
4. The appraiser will not give testimony or appear in court because he or she made an appraisal of the property in question,
unless specific arrangements to do so have been made beforehand, or as otherwise required by law.
5. The appraiser has noted in this appraisal report any adverse conditions (such as needed repairs, deterioration, the
presence of hazardous wastes, toxic substances, etc.) observed during the inspection of the subject property or that he or
she became aware of during the research involved in performing this appraisal. Unless otherwise stated in this appraisal
report, the appraiser has no knowledge of any hidden or unapparent physical deficiencies or adverse conditions of the
property (such as, but not limited to, needed repairs, deterioration, the presence of hazardous wastes, toxic substances,
adverse environmental conditions, etc.) that would make the property less valuable, and has assumed that there are no such
conditions and makes no guarantees or warranties, express or implied. The appraiser will not be responsible for any such
conditions that do exist or for any engineering or testing that might be required to discover whether such conditions exist.
Because the appraiser is not an expert in the field of environmental hazards, this appraisal report must not be considered as
an environmental assessment of the property.
6. The appraiser has based his or her appraisal report and valuation conclusion for an appraisal that is subject to satisfactory
completion, repairs, or alterations on the assumption that the completion, repairs, or alterations of the subject property will
be performed in a professional manner.
Freddie Mac Form 70 March 2005
Page 4 of 6
Fannie Mae Form 1004 March 2005
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FIGURE 9.3: Uniform Residential Appraisal Report (continued)
Uniform Residential Appraisal Report
File #
APPRAISER’S CERTIFICATION: The Appraiser certifies and agrees that:
1. I have, at a minimum, developed and reported this appraisal in accordance with the scope of work requirements stated in
this appraisal report.
2. I performed a complete visual inspection of the interior and exterior areas of the subject property. I reported the condition
of the improvements in factual, specific terms. I identified and reported the physical deficiencies that could affect the
livability, soundness, or structural integrity of the property.
3. I performed this appraisal in accordance with the requirements of the Uniform Standards of Professional Appraisal
Practice that were adopted and promulgated by the Appraisal Standards Board of The Appraisal Foundation and that were in
place at the time this appraisal report was prepared.
4. I developed my opinion of the market value of the real property that is the subject of this report based on the sales
comparison approach to value. I have adequate comparable market data to develop a reliable sales comparison approach
for this appraisal assignment. I further certify that I considered the cost and income approaches to value but did not develop
them, unless otherwise indicated in this report.
5. I researched, verified, analyzed, and reported on any current agreement for sale for the subject property, any offering for
sale of the subject property in the twelve months prior to the effective date of this appraisal, and the prior sales of the subject
property for a minimum of three years prior to the effective date of this appraisal, unless otherwise indicated in this report.
6. I researched, verified, analyzed, and reported on the prior sales of the comparable sales for a minimum of one year prior
to the date of sale of the comparable sale, unless otherwise indicated in this report.
7. I selected and used comparable sales that are locationally, physically, and functionally the most similar to the subject property.
8. I have not used comparable sales that were the result of combining a land sale with the contract purchase price of a home that
has been built or will be built on the land.
9. I have reported adjustments to the comparable sales that reflect the market's reaction to the differences between the subject
property and the comparable sales.
10. I verified, from a disinterested source, all information in this report that was provided by parties who have a financial interest in
the sale or financing of the subject property.
11. I have knowledge and experience in appraising this type of property in this market area.
12. I am aware of, and have access to, the necessary and appropriate public and private data sources, such as multiple listing
services, tax assessment records, public land records and other such data sources for the area in which the property is located.
13. I obtained the information, estimates, and opinions furnished by other parties and expressed in this appraisal report from
reliable sources that I believe to be true and correct.
14. I have taken into consideration the factors that have an impact on value with respect to the subject neighborhood, subject
property, and the proximity of the subject property to adverse influences in the development of my opinion of market value. I
have noted in this appraisal report any adverse conditions (such as, but not limited to, needed repairs, deterioration, the
presence of hazardous wastes, toxic substances, adverse environmental conditions, etc.) observed during the inspection of the
subject property or that I became aware of during the research involved in performing this appraisal. I have considered these
adverse conditions in my analysis of the property value, and have reported on the effect of the conditions on the value and
marketability of the subject property.
15. I have not knowingly withheld any significant information from this appraisal report and, to the best of my knowledge, all
statements and information in this appraisal report are true and correct.
16. I stated in this appraisal report my own personal, unbiased, and professional analysis, opinions, and conclusions, which
are subject only to the assumptions and limiting conditions in this appraisal report.
17. I have no present or prospective interest in the property that is the subject of this report, and I have no present or
prospective personal interest or bias with respect to the participants in the transaction. I did not base, either partially or
completely, my analysis and/or opinion of market value in this appraisal report on the race, color, religion, sex, age, marital
status, handicap, familial status, or national origin of either the prospective owners or occupants of the subject property or of the
present owners or occupants of the properties in the vicinity of the subject property or on any other basis prohibited by law.
18. My employment and/or compensation for performing this appraisal or any future or anticipated appraisals was not
conditioned on any agreement or understanding, written or otherwise, that I would report (or present analysis supporting) a
predetermined specific value, a predetermined minimum value, a range or direction in value, a value that favors the cause of
any party, or the attainment of a specific result or occurrence of a specific subsequent event (such as approval of a pending
mortgage loan application).
19. I personally prepared all conclusions and opinions about the real estate that were set forth in this appraisal report. If I
relied on significant real property appraisal assistance from any individual or individuals in the performance of this appraisal
or the preparation of this appraisal report, I have named such individual(s) and disclosed the specific tasks performed in this
appraisal report. I certify that any individual so named is qualified to perform the tasks. I have not authorized anyone to make
a change to any item in this appraisal report; therefore, any change made to this appraisal is unauthorized and I will take no
responsibility for it.
20. I identified the lender/client in this appraisal report who is the individual, organization, or agent for the organization that
ordered and will receive this appraisal report.
Freddie Mac Form 70 March 2005
Page 5 of 6
Fannie Mae Form 1004 March 2005
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191
Unit 9 Transaction Process and Closing
FIGURE 9.3: Uniform Residential Appraisal Report (continued)
Uniform Residential Appraisal Report
File #
21. The lender/client may disclose or distribute this appraisal report to: the borrower; another lender at the request of the
borrower; the mortgagee or its successors and assigns; mortgage insurers; government sponsored enterprises; other
secondary market participants; data collection or reporting services; professional appraisal organizations; any department,
agency, or instrumentality of the United States; and any state, the District of Columbia, or other jurisdictions; without having to
obtain the appraiser’s or supervisory appraiser’s (if applicable) consent. Such consent must be obtained before this appraisal
report may be disclosed or distributed to any other party (including, but not limited to, the public through advertising, public
relations, news, sales, or other media).
22. I am aware that any disclosure or distribution of this appraisal report by me or the lender/client may be subject to certain
laws and regulations. Further, I am also subject to the provisions of the Uniform Standards of Professional Appraisal Practice
that pertain to disclosure or distribution by me.
23. The borrower, another lender at the request of the borrower, the mortgagee or its successors and assigns, mortgage
insurers, government sponsored enterprises, and other secondary market participants may rely on this appraisal report as part
of any mortgage finance transaction that involves any one or more of these parties.
24. If this appraisal report was transmitted as an “electronic record” containing my “electronic signature,” as those terms are
defined in applicable federal and/or state laws (excluding audio and video recordings), or a facsimile transmission of this
appraisal report containing a copy or representation of my signature, the appraisal report shall be as effective, enforceable and
valid as if a paper version of this appraisal report were delivered containing my original hand written signature.
25. Any intentional or negligent misrepresentation(s) contained in this appraisal report may result in civil liability and/or
criminal penalties including, but not limited to, fine or imprisonment or both under the provisions of Title 18, United States
Code, Section 1001, et seq., or similar state laws.
SUPERVISORY APPRAISER’S CERTIFICATION: The Supervisory Appraiser certifies and agrees that:
1. I directly supervised the appraiser for this appraisal assignment, have read the appraisal report, and agree with the appraiser’s
analysis, opinions, statements, conclusions, and the appraiser’s certification.
2. I accept full responsibility for the contents of this appraisal report including, but not limited to, the appraiser’s analysis, opinions,
statements, conclusions, and the appraiser’s certification.
3. The appraiser identified in this appraisal report is either a sub-contractor or an employee of the supervisory appraiser (or the
appraisal firm), is qualified to perform this appraisal, and is acceptable to perform this appraisal under the applicable state law.
4. This appraisal report complies with the Uniform Standards of Professional Appraisal Practice that were adopted and
promulgated by the Appraisal Standards Board of The Appraisal Foundation and that were in place at the time this appraisal
report was prepared.
5. If this appraisal report was transmitted as an “electronic record” containing my “electronic signature,” as those terms are
defined in applicable federal and/or state laws (excluding audio and video recordings), or a facsimile transmission of this
appraisal report containing a copy or representation of my signature, the appraisal report shall be as effective, enforceable and
valid as if a paper version of this appraisal report were delivered containing my original hand written signature.
APPRAISER
SUPERVISORY APPRAISER (ONLY IF REQUIRED)
Signature______________________________________________
Name ________________________________________________
Company Name ________________________________________
Company Address_______________________________________
_____________________________________________________
Telephone Number ______________________________________
Email Address __________________________________________
Date of Signature and Report ______________________________
Effective Date of Appraisal ________________________________
State Certification #______________________________________
or State License # _______________________________________
or Other (describe) __________________ State # _____________
State _________________________________________________
Expiration Date of Certification or License ____________________
Signature ___________________________________________
Name ______________________________________________
Company Name _____________________________________
Company Address ____________________________________
__________________________________________________
Telephone Number ___________________________________
Email Address _______________________________________
Date of Signature ____________________________________
State Certification # ___________________________________
or State License # ____________________________________
State ______________________________________________
Expiration Date of Certification or License _________________
SUPERVISORY APPRAISER
SUBJECT PROPERTY
ADDRESS OF PROPERTY APPRAISED
_____________________________________________________
_____________________________________________________
APPRAISED VALUE OF SUBJECT PROPERTY $ _____________
Did not inspect subject property
Did inspect exterior of subject property from street
Date of Inspection _________________________________
Did inspect interior and exterior of subject property
Date of Inspection _________________________________
LENDER/CLIENT
Name ________________________________________________
Company Name ________________________________________
Company Address_______________________________________
_____________________________________________________
Email Address __________________________________________
Freddie Mac Form 70 March 2005
COMPARABLE SALES
Page 6 of 6
Did not inspect exterior of comparable sales from street
Did inspect exterior of comparable sales from street
Date of Inspection _________________________________
Fannie Mae Form 1004 March 2005
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An appraisal to determine the market value of a residential property is usually
based on a sales comparison approach in which the subject property is evaluated
in comparison with other similar properties in the same locale that have recently
sold. Adjustments are made to reflect what those properties would have sold for if
they exactly matched the subject property. See Figure 9.4 for an illustration of the
sales comparison approach to value.
FIGURE 9.4: Sales Comparison Approach to Value
Comparable Properties
Subject Property
Sales Price
Financing
concessions
none
Date of sale
A
B
C
$260,000
$252,000
$265,000
none
none
none
current
current
current
Location
good
same
poorer +6,500
same
Age
6 years
same
same
same
Size of lot
60’ × 135’
same
same
larger –5,000
Landscaping
good
same
same
same
No. of rooms
brick
same
same
same
No. of bedrooms
ranch
same
same
same
No. of baths
6
same
same
same
Sq. ft. of living
space
3
same
poorer +500
same
1½
same
same
better –500
Other space
(basement)
1,500
same
same
better –1,000
full basement
same
same
same
average
better –1,500
poorer +1,000
better –1,500
good
same
same
better –500
2-car attached
same
same
same
none
none
none
none
Construction
Style
Condition—exterior
Condition—interior
Garage
Other
improvements
Net adjustments
–1,500
+8,000
–8,500
Adjusted value
$258,500
$260,000
$256,500
Note that the value of a feature that is present in the subject but not in the comparable property is
added to the sales price of the comparable. Likewise, the value of a feature that is present in the comparable but not in the subject property is subtracted. A good way to remember this is CBS CPA: CBS
stands for “comp better subtract” and CPA stands for “comp poorer add.” The adjusted sales prices
of the comparables represent the probable range of value of the subject property. From this range, a
single market value estimate can be selected.
For a unique property such as a church, the appraiser could use the cost approach,
which is based on the current replacement cost of the improvements less depreciation, which is calculated over the anticipated life of the property. The income
approach is used to measure the present worth of a property’s income stream with
the rate of return required by the investor.
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Unit 9 Transaction Process and Closing
193
Clear Title Another part of the loan approval process is receiving notification of
clear title to the property. As discussed in Unit 8, a search of title records is made,
and any defects called a cloud on the title must be resolved to the satisfaction of
the lender, as well as the buyer. The lender will also require a title insurance policy
in an amount adequate to protect the lender’s investment.
Homeowners Insurance The lender requires the borrowers to produce proof
of homeowners insurance that will cover any loss because of physical hazards or
liability. Due to the number of natural disasters, such as Hurricane Katrina, tornadoes, and earthquakes, obtaining homeowners insurance has become more complicated than in previous years, and it needs to be addressed earlier in the process.
Flood insurance is required for any property within Federal Emergency Management Agency (FEMA) declared flood zones.
Underwriting After the loan package is complete, it is submitted to an underwriter who will approve, reject, or return the package to processing with contingency requirements that must be met before resubmission for approval. Once the
loan has been approved by the underwriter, the package is sent to the lender’s closing department, where the various loan documents are prepared and sent to the
closing agent, and the escrow or impound account for the collection of property
taxes and insurance is set up.
Final Approval An approved loan commitment is now communicated to all
parties involved in the transaction, obligating the lender to issue the loan under
the agreed terms and conditions. This commitment is only good for a fairly short
period. Any delay in settlement might result in a required resubmission.
INSPECTIONS
A contract often includes a contingency on the purchaser receiving a satisfactory
report on one or more types of inspections (see Unit 6). In many parts of the country, the seller is responsible for providing a satisfactory report regarding termites
or other wood-boring insects. The seller is usually also responsible for making any
repairs that are needed.
The most common inspection required by the buyer is a home inspection, which
is highly recommended for all purchasers, but especially for first-time homebuyers.
Other typical inspections include those for the presence of hazardous substances
such as lead-based paint or radon.
A time frame should be established for completion of the inspection in order for
the contingency to be removed as soon as possible. After receiving a report from
the inspector, the purchaser can either remove the contingency or prepare a list
of requested items for repair or replacement to be submitted to the seller on an
addendum form. A time frame during which the seller must respond should be
included. The seller may agree to comply with the entire list, but in many cases,
will agree to certain items while refusing others. This then becomes a counteroffer
and is returned to the buyer for acceptance, rejection, or further counter.
The agreed repairs and/or replacements must be completed before the final walkthrough inspection or the seller may be at risk of default. In a case where the
required repair or replacement must occur after closing, the seller should be able
to provide proof that the work is scheduled and paid for.
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TITLE WORK
As previously mentioned, the lender will require proof of clear title before granting final approval of the loan. During the time the loan has been in process and
the necessary inspections and repairs/replacements are taking place, the closing
attorney or the title company has been conducting the necessary title work.
The chain of title showing ownership has been searched for at least a period of
60 years. Public records have been searched and an abstract of title prepared. The
sales contract is usually contingent on the purchaser’s receiving marketable title
to the property. This means that any defects found must be resolved so that the
purchaser will not have any problem selling the property in the future. As long
as the contract is contingent on the buyer’s receiving clear title, the seller is obligated to take whatever steps are necessary to correct the problem.
A title insurance policy will be required by the lender to cover the amount of the
loan. For an additional fee, the purchaser can buy an owner’s policy that covers
the full value of the property. Title insurance is a one-time charge and protects
against any claims made to the property in the future (for more information on the
conveyance of title, see Unit 8).
PREPARATION FOR CLOSING
The selection of an attorney, escrow agent, or title company agent to handle the
closing of the loan and the conveyance of title was noted on the original contract of sale, along with a projected date for settlement. Hopefully, there has been
good communication between the lender, the closing agent, the buyer and seller,
and their respective agents throughout the transaction process. At this point, the
exact date, time, and place for closing should be determined with notice given to
all parties. In a case where one of the principals to the transaction is unable to
attend, it may be possible to have a power-of-attorney prepared that gives the right
for another person to sign on his behalf. This is to be avoided unless absolutely
necessary and may not be satisfactory to a lender. The closing agent, the buyer,
and the seller all have special duties to perform as the settlement date approaches.
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Unit 9 Transaction Process and Closing
195
Closing Agent The closing agent must prepare the deed and the Closing Disclosure (see Figure 9.5). A Closing Disclosure is an accounting of the parties’
debits and credits. A debit is a charge—an amount that a party owes and must pay
at closing. A credit is an amount entered in a person’s favor—an amount that has
already been paid, an amount being reimbursed, or an amount the buyer promises
to pay in the form of a loan.
The loan documents are prepared by the lender but will need to be reviewed.
Additional information that will be needed for the Closing Disclosure includes
the following:
■■ The final pay-off figure for any existing loan, effective date of closing, the
unpaid amount of principal, the interest due through the date of payment,
the fee for issuing the certificate of satisfaction or release deed, credits (if
any) for tax and insurance reserves, and the amount of any prepayment
penalties. The same procedure is followed for any other liens that must be
released.
■■ The exact balance of the loan as of the closing date, if the buyer will assume
the seller’s existing mortgage loan. Usually, the lender is required to provide
the buyer with a mortgage reduction certificate, which certifies the amount
owed on the mortgage loan, the interest rate, and the date and amount of
the last interest payment.
■■ Proration of property taxes and condominium or homeowners association
fees
■■ Any credits or other adjustments made between buyer and seller
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FIGURE 9.5: Sample Closing Disclosure
This form is a statement of final loan terms and closing costs. Compare this
document with your Loan Estimate.
Closing Disclosure
Closing Information
Date Issued
Closing Date
Disbursement Date
Settlement Agent
File #
Property
Sale Price
Transaction Information
4/15/2013
4/15/2013
4/15/2013
Epsilon Title Co.
12-3456
456 Somewhere Ave
Anytown, ST 12345
$180,000
Borrower
Seller
Lender
Loan Information
Michael Jones and Mary Stone
123 Anywhere Street
Anytown, ST 12345
Steve Cole and Amy Doe
321 Somewhere Drive
Anytown, ST 12345
Ficus Bank
Loan Terms
Loan Term
Purpose
Product
30 years
Purchase
Fixed Rate
Loan Type
x Conventional
FHA
VA
_____________
123456789
000654321
Loan ID #
MIC #
Can this amount increase after closing?
Loan Amount
$162,000
NO
Interest Rate
3.875%
NO
Monthly Principal & Interest
$761.78
NO
See Projected Payments below for your
Estimated Total Monthly Payment
Does the loan have these features?
Prepayment Penalty
YES
Balloon Payment
NO
• As high as $3,240 if you pay off the loan during the
first 2 years
Projected Payments
Payment Calculation
Years 1-7
Principal & Interest
Years 8-30
$761.78
$761.78
Mortgage Insurance
+
82.35
+
Estimated Escrow
+
206.13
+
Amount can increase over time
Estimated Total
Monthly Payment
Estimated Taxes, Insurance
& Assessments
Amount can increase over time
See page 4 for details
$1,050.26
$356.13
a month
This estimate includes
x Property Taxes
x Homeowner’s Insurance
x Other: Homeowner’s Association Dues
—
206.13
$967.91
In escrow?
YES
YES
NO
See Escrow Account on page 4 for details. You must pay for other property
costs separately.
Costs at Closing
Closing Costs
$9,712.10
Includes $4,694.05 in Loan Costs + $5,018.05 in Other Costs – $0
in Lender Credits. See page 2 for details.
Cash to Close
$14,147.26
Includes Closing Costs. See Calculating Cash to Close on page 3 for details.
CLOSING DISCLOSURE
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Unit 9 Transaction Process and Closing
FIGURE 9.5: Sample Closing Disclosure (continued)
Closing Cost Details
Borrower-Paid
At Closing Before Closing
Loan Costs
A. Origination Charges
01 0.25 % of Loan Amount (Points)
02 Application Fee
03 Underwriting Fee
04
05
06
07
08
B. Services Borrower Did Not Shop For
01 Appraisal Fee
to John Smith Appraisers Inc.
02 Credit Report Fee
to Information Inc.
03 Flood Determination Fee
to Info Co.
04 Flood Monitoring Fee
to Info Co.
05 Tax Monitoring Fee
to Info Co.
06 Tax Status Research Fee
to Info Co.
07
08
09
10
C. Services Borrower Did Shop For
01 Pest Inspection Fee
to Pests Co.
02 Survey Fee
to Surveys Co.
03 Title – Insurance Binder
to Epsilon Title Co.
04 Title – Lender’s Title Insurance
to Epsilon Title Co.
05 Title – Settlement Agent Fee
to Epsilon Title Co.
06 Title – Title Search
to Epsilon Title Co.
07
08
D. TOTAL LOAN COSTS (Borrower-Paid)
$1,802.00
$405.00
$300.00
$1,097.00
Loan Costs Subtotals (A + B + C)
$4,664.25
Seller-Paid
At Closing Before Closing
Paid by
Others
$236.55
$405.00
$29.80
$20.00
$31.75
$75.00
$80.00
$2,655.50
$120.50
$85.00
$650.00
$500.00
$500.00
$800.00
$4,694.05
$29.80
Other Costs
E. Taxes and Other Government Fees
01 Recording Fees
Deed: $40.00
Mortgage: $45.00
02 Transfer Tax
to Any State
F. Prepaids
01 Homeowner’s Insurance Premium ( 12 mo.) to Insurance Co.
02 Mortgage Insurance Premium ( mo.)
03 Prepaid Interest ( $17.44 per day from 4/15/13 to 5/1/13 )
04 Property Taxes ( 6 mo.) to Any County USA
05
G. Initial Escrow Payment at Closing
01 Homeowner’s Insurance $100.83 per month for 2 mo.
02 Mortgage Insurance
per month for mo.
03 Property Taxes
$105.30 per month for 2 mo.
04
05
06
07
08 Aggregate Adjustment
H. Other
01 HOA Capital Contribution
to HOA Acre Inc.
02 HOA Processing Fee
to HOA Acre Inc.
03 Home Inspection Fee
to Engineers Inc.
04 Home Warranty Fee
to XYZ Warranty Inc.
05 Real Estate Commission
to Alpha Real Estate Broker
06 Real Estate Commission
to Omega Real Estate Broker
07 Title – Owner’s Title Insurance (optional) to Epsilon Title Co.
08
I. TOTAL OTHER COSTS (Borrower-Paid)
Other Costs Subtotals (E + F + G + H)
J. TOTAL CLOSING COSTS (Borrower-Paid)
Closing Costs Subtotals (D + I)
Lender Credits
CLOSING DISCLOSURE
$85.00
$85.00
$950.00
$2,120.80
$1,209.96
$279.04
$631.80
$412.25
$201.66
$210.60
– 0.01
$2,400.00
$500.00
$150.00
$750.00
$750.00
$450.00
$5,700.00
$5,700.00
$1,000.00
$5,018.05
$5,018.05
$9,712.10
$9,682.30
$29.80
$12,800.00
$750.00
$405.00
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FIGURE 9.5: Sample Closing Disclosure (continued)
Calculating Cash to Close
Use this table to see what has changed from your Loan Estimate.
Loan Estimate
Total Closing Costs (J)
Final
Did this change?
$8,054.00
$9,712.10
YES
• See Total Loan Costs (D) and Total Other Costs (I)
$0
– $29.80
YES
• You paid these Closing Costs before closing
Closing Costs Paid Before Closing
Closing Costs Financed
(Paid from your Loan Amount)
Down Payment/Funds from Borrower
Deposit
$0
$0
NO
$18,000.00
$18,000.00
NO
NO
– $10,000.00
– $10,000.00
Funds for Borrower
$0
$0
NO
Seller Credits
$0
– $2,500.00
YES
• See Seller Credits in Section L
Adjustments and Other Credits
$0
– $1,035.04
YES
• See details in Sections K and L
$16,054.00
$14,147.26
Cash to Close
Summaries of Transactions
Use this table to see a summary of your transaction.
BORROWER’S TRANSACTION
SELLER’S TRANSACTION
K. Due from Borrower at Closing
$189,762.30
01 Sale Price of Property
02 Sale Price of Any Personal Property Included in Sale
03 Closing Costs Paid at Closing (J)
04
Adjustments
05
06
07
Adjustments for Items Paid by Seller in Advance
08
City/Town Taxes
to
09
County Taxes
to
10
Assessments
to
11
HOA Dues
4/15/13 to 4/30/13
12
13
14
15
$180,000.00
L. Paid Already by or on Behalf of Borrower at Closing
01 Deposit
02 Loan Amount
03 Existing Loan(s) Assumed or Taken Subject to
04
05 Seller Credit
Other Credits
06 Rebate from Epsilon Title Co.
07
Adjustments
08
09
10
11
Adjustments for Items Unpaid by Seller
12
City/Town Taxes 1/1/13 to 4/14/13
13
County Taxes
to
14
Assessments
to
15
16
17
$175,615.04
$10,000.00
$162,000.00
$9,682.30
$80.00
$2,500.00
$750.00
$365.04
M. Due to Seller at Closing
$180,000.00
N. Due from Seller at Closing
01 Excess Deposit
02 Closing Costs Paid at Closing (J)
03 Existing Loan(s) Assumed or Taken Subject to
04 Payoff of First Mortgage Loan
05 Payoff of Second Mortgage Loan
06
07
08 Seller Credit
09
10
11
12
13
Adjustments for Items Unpaid by Seller
14
City/Town Taxes 1/1/13 to 4/14/13
15
County Taxes
to
16
Assessments
to
17
18
19
$115,665.04
CALCULATION
CALCULATION
Total Due from Borrower at Closing (K)
$189,762.30
Total Paid Already by or on Behalf of Borrower at Closing (L) – $175,615.04
Total Due to Seller at Closing (M)
Total Due from Seller at Closing (N)
Cash to Close x From
Cash
CLOSING DISCLOSURE
To Borrower
$14,147.26
$180,080.00
01 Sale Price of Property
02 Sale Price of Any Personal Property Included in Sale
03
04
05
06
07
08
Adjustments for Items Paid by Seller in Advance
09 City/Town Taxes
to
10 County Taxes
to
11 Assessments
to
12 HOA Dues
4/15/13 to 4/30/13
13
14
15
16
$80.00
$12,800.00
$100,000.00
$2,500.00
$365.04
$180,080.00
– $115,665.04
From x To Seller
$64,414.96
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Unit 9 Transaction Process and Closing
FIGURE 9.5: Sample Closing Disclosure (continued)
Additional Information About This Loan
Loan Disclosures
Assumption
If you sell or transfer this property to another person, your lender
will allow, under certain conditions, this person to assume this
loan on the original terms.
x will not allow assumption of this loan on the original terms.
Demand Feature
Your loan
has a demand feature, which permits your lender to require early
repayment of the loan. You should review your note for details.
x does not have a demand feature.
Late Payment
If your payment is more than 15 days late, your lender will charge a
late fee of 5% of the monthly principal and interest payment.
Negative Amortization (Increase in Loan Amount)
Under your loan terms, you
are scheduled to make monthly payments that do not pay all of
the interest due that month. As a result, your loan amount will
increase (negatively amortize), and your loan amount will likely
become larger than your original loan amount. Increases in your
loan amount lower the equity you have in this property.
may have monthly payments that do not pay all of the interest
due that month. If you do, your loan amount will increase
(negatively amortize), and, as a result, your loan amount may
become larger than your original loan amount. Increases in your
loan amount lower the equity you have in this property.
x do not have a negative amortization feature.
Partial Payments
Your lender
x may accept payments that are less than the full amount due
(partial payments) and apply them to your loan.
may hold them in a separate account until you pay the rest of the
payment, and then apply the full payment to your loan.
does not accept any partial payments.
If this loan is sold, your new lender may have a different policy.
Security Interest
You are granting a security interest in
456 Somewhere Ave., Anytown, ST 12345
You may lose this property if you do not make your payments or
satisfy other obligations for this loan.
CLOSING DISCLOSURE
Escrow Account
For now, your loan
x will have an escrow account (also called an “impound” or “trust”
account) to pay the property costs listed below. Without an escrow
account, you would pay them directly, possibly in one or two large
payments a year. Your lender may be liable for penalties and interest
for failing to make a payment.
Escrow
Escrowed
Property Costs
over Year 1
$2,473.56
Estimated total amount over year 1 for
your escrowed property costs:
Homeowner’s Insurance
Property Taxes
Non-Escrowed
Property Costs
over Year 1
$1,800.00
Estimated total amount over year 1 for
your non-escrowed property costs:
Homeowner’s Association Dues
You may have other property costs.
Initial Escrow
Payment
$412.25
A cushion for the escrow account you
pay at closing. See Section G on page 2.
Monthly Escrow
Payment
$206.13
The amount included in your total
monthly payment.
will not have an escrow account because you declined it
your
lender does not offer one. You must directly pay your property
costs, such as taxes and homeowner’s insurance. Contact your
lender to ask if your loan can have an escrow account.
No Escrow
Estimated
Property Costs
over Year 1
Estimated total amount over year 1. You
must pay these costs directly, possibly
in one or two large payments a year.
Escrow Waiver Fee
In the future,
Your property costs may change and, as a result, your escrow payment may change. You may be able to cancel your escrow account,
but if you do, you must pay your property costs directly. If you fail
to pay your property taxes, your state or local government may (1)
impose fines and penalties or (2) place a tax lien on this property. If
you fail to pay any of your property costs, your lender may (1) add
the amounts to your loan balance, (2) add an escrow account to your
loan, or (3) require you to pay for property insurance that the lender
buys on your behalf, which likely would cost more and provide fewer
benefits than what you could buy on your own.
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FIGURE 9.5: Sample Closing Disclosure (continued)
Loan Calculations
Other Disclosures
Total of Payments. Total you will have paid after
you make all payments of principal, interest,
mortgage insurance, and loan costs, as scheduled.
$285,803.36
Finance Charge. The dollar amount the loan will
cost you.
$118,830.27
Amount Financed. The loan amount available after
paying your upfront finance charge.
$162,000.00
Annual Percentage Rate (APR). Your costs over
the loan term expressed as a rate. This is not your
interest rate.
Total Interest Percentage (TIP). The total amount
of interest that you will pay over the loan term as a
percentage of your loan amount.
?
4.174%
69.46%
Questions? If you have questions about the
loan terms or costs on this form, use the contact
information below. To get more information
or make a complaint, contact the Consumer
Financial Protection Bureau at
www.consumerfinance.gov/mortgage-closing
Appraisal
If the property was appraised for your loan, your lender is required to
give you a copy at no additional cost at least 3 days before closing.
If you have not yet received it, please contact your lender at the
information listed below.
Contract Details
See your note and security instrument for information about
• what happens if you fail to make your payments,
• what is a default on the loan,
• situations in which your lender can require early repayment of the
loan, and
• the rules for making payments before they are due.
Liability after Foreclosure
If your lender forecloses on this property and the foreclosure does not
cover the amount of unpaid balance on this loan,
x state law may protect you from liability for the unpaid balance. If you
refinance or take on any additional debt on this property, you may
lose this protection and have to pay any debt remaining even after
foreclosure. You may want to consult a lawyer for more information.
state law does not protect you from liability for the unpaid balance.
Refinance
Refinancing this loan will depend on your future financial situation,
the property value, and market conditions. You may not be able to
refinance this loan.
Tax Deductions
If you borrow more than this property is worth, the interest on the
loan amount above this property’s fair market value is not deductible
from your federal income taxes. You should consult a tax advisor for
more information.
Contact Information
Lender
Mortgage Broker
Real Estate Broker
(B)
Real Estate Broker
(S)
Settlement Agent
Name
Ficus Bank
FRIENDLY MORTGAGE
BROKER INC.
Omega Real Estate
Broker Inc.
Alpha Real Estate
Broker Co.
Epsilon Title Co.
Address
4321 Random Blvd.
Somecity, ST 12340
1234 Terrapin Dr.
Somecity, MD 54321
789 Local Lane
Sometown, ST 12345
45
987 Suburb Ct.
Someplace, ST 12340
123 Commerce Pl.
Somecity, ST 12344
Z765416
Z61456
Z61616
Samuel Green
Joseph Cain
Sarah Arnold
P16415
P51461
PT1234
NMLS ID
222222
ST License ID
Contact
Joe Smith
JIM TAYLOR
Contact NMLS ID
12345
394784
Contact
ST License ID
Email
[email protected]
ficusbank.com
[email protected]
FRNDLYMTGBRKR.CM
[email protected]
[email protected]
[email protected]
epsilontitle.com
Phone
123-456-7890
333-444-5555
123-555-1717
321-555-7171
987-555-4321
Confirm Receipt
By signing, you are only confirming that you have received this form. You do not have to accept this loan because you have signed or received
this form.
Applicant Signature
Date
CLOSING DISCLOSURE
Co-Applicant Signature
Date
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Unit 9 Transaction Process and Closing
The closing agent examines the title commitment or the abstract that was issued
several days or weeks before the closing. Because liens may have been filed during
the interval, two searches of the public record are often made. The first search
shows the status of the seller’s title on that date. The second search, called a bring
down, is made after the closing and before any new documents are filed.
Buyer The buyer has many tasks to complete in the last few days before closing:
■■ Arrangements must be made for transferring utilities to the buyer’s name.
■■
■■
■■
■■
If the buyer is new to an area, a deposit may be required from the utility
company.
A change of address needs to be filed, along with transfer of cable or television systems.
The buyer conducts a walk-through, or final inspection, to verify that all
necessary repairs have been made, that the property has been well maintained, and that all systems and fixtures are in substantially the same
condition that they were in at the time the contract was finalized. The walkthrough should be done shortly before closing. Any problems uncovered will
be handled at the settlement table.
The Closing Disclosure will be sent to the parties three days prior to closing
and should be reviewed. The third page of the Closing Disclosure compares
the actual cost to the cost on the Loan Estimate provided at application.
Obtain a cashier’s check or certified funds to bring to closing. (Note that
banks may not be open after 4:00 pm or on the weekend.)
Seller The seller also has many arrangements to make:
Pack and confirm moving day and time.
Remove any items that are not to convey.
Put in a change of address and stop newspapers.
Collect instruction booklets and/or warranties on appliances to give
purchaser.
■■ Collect all keys to the property to be turned over to the buyer.
■■ Verify that all conditions required by inspection or other contingencies have
been met.
■■ Arrange for a thorough cleaning of the property before the walk-through.
■■ Review the Closing Disclosure, if available.
■■
■■
■■
■■
In some states, the sellers may be required to execute an affidavit of title. This affidavit is a sworn statement in which the sellers assure the title insurance company
(and the buyer) that no other defects in the title have occurred since the date of
the title examination (e.g., judgments, bankruptcies, divorces, unrecorded deeds
or contracts, unpaid repairs or improvements that might lead to mechanics’ liens).
The affidavit gives the title insurance company a basis on which to sue the sellers
should their statements in the affidavit be incorrect.
In areas where real estate sales transactions are customarily closed through an
escrow, the escrow instructions usually provide for an extended coverage policy
to be issued to the buyer effective the date of closing. The seller has no need to
execute an affidavit of title.
Licensees often assist in preclosing arrangements as part
of their service to clients. In some states, licensees are required to advise the parties
of the approximate expenses involved in closing when a real estate sales contract is
I N
P R A C T I C E
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signed. In other states, licensees have a statutory duty to coordinate and supervise
closing activities. Aside from state laws on this issue, a licensee without a specific role
in the closing may still be the person with the most knowledge about the transaction.
Because of this, many licensees feel it is part of their fiduciary duty to be present at a
face-to-face closing.
SAMPLE CHECKLIST
A sample checklist of the process from offer and acceptance to the actual closing
is shown in Figure 9.6. Some steps may occur simultaneously and depend on the
geographic location of the property and local custom; some steps may occur in a
different order than that given. Generally, the checklist provides an easy reminder
of each of the steps involved. Actual dates for actions initiated or completed can
be filled in for each step. Attention must be paid to specified time frames set for
any action to take place. If the action is not completed within the given time
frame, the contract may be voidable.
FIGURE 9.6: Contract to Closing Checklist
__________ 1. Offer to purchase including any contingencies, amendments, and/or addenda signed and initialed where necessary
by both buyers and sellers. Offer becomes a sales contract.
__________ 2. Earnest money deposited by broker according to state law.
__________ 3. Copy of contract sent to closing agent to initiate title work.
__________ 4. Buyer makes formal application for financing as described in sales contract. (Buyer may have presented a preapproval letter along with original offer to purchase.)
__________ 5. Lender provides borrower with Loan Estimate within three days of application.
__________ 6. Lender orders credit report and appraisal.
__________ 7. Buyer orders any property inspections as required by contingency to contract.
__________ 8. Either buyer or seller orders termite (or wood-boring insects) report.
__________ 9. Copy of inspection report, along with list of requested corrections, provided to seller.
__________ 10. Final loan approval letter received from lender.
__________ 11. Seller makes arrangements for any repairs required as a result of inspection reports, or any repairs required by the
lender.
__________ 12. Closing agent orders title search and survey, if required.
__________ 13. Any defects in the title are brought to the attention of the seller for resolution.
__________ 14. Closing agent obtains title insurance policies for lender and new owner.
__________ 15. Buyer arranges for homeowners insurance with copy sent to closing agent.
__________ 16. Definite closing date, time, and place are set with notice to buyer and seller.
__________ 17. Lender prepares mortgage documents and sends to closing agent.
__________ 18. Closing agent obtains payoff figures for any existing mortgages.
__________ 19. Closing agent prepares deed and the Closing Disclosure is delivered three days prior to closing.
__________ 20. Buyer confirms closing figures on Closing Disclosure with closing agent.
__________ 21. Buyer arranges for utilities hook-up, confirms with movers and post office.
__________ 22. Buyer makes walk-through inspection of premises.
__________ 23. Buyer arranges for cashier’s check or certified funds to bring to closing.
__________ 24. Closing takes place (seller is reminded to bring keys and garage door openers).
__________ 25. Deficiencies determined by the walk-through inspection to be resolved at the settlement table or closing rescheduled
for a later date.
__________ 26. Closing agent records deed and loan documents.
__________ 27. Closing agent makes pay-off on existing loans.
__________ 28. Closing agent distributes funds to seller and brokers.
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Unit 9 Transaction Process and Closing
203
CONDUCTING THE CLOSING
Closing is called by many names. For example, in some areas, closing is called settlement, or settlement and transfer. In some parts of the country, the parties in the
transaction sit around a table and exchange copies of documents, a process called
passing papers (“We passed papers on the new house Wednesday morning”). In
other regions, the buyer and the seller never meet; the paperwork is handled by an
escrow agent in a process called closing escrow (“We’ll close escrow on our house
next week”). The main concerns are that the buyer receives marketable title and
that the seller receives the purchase price.
In a face-to-face closing, the
parties meet face to face.
The western states that were influenced primarily by Spanish law generally close
“in escrow.” In the middle and eastern parts of the country, closing (or settlement)
is done by either an attorney or a title company escrow agent.
Face-to-Face Closing
Face-to-face closings may be held at the office of the title company, the lending
institution, an attorney for one of the parties, the broker, the county recorder, or
the escrow company. Those attending a closing may include
■■ the buyer;
■■ the seller;
■■ the real estate salespeople or brokers (both the buyer’s and the seller’s
agents);
■■ the seller’s and the buyer’s attorneys;
■■ representatives of the lending institutions involved with the buyer’s new
mortgage loan, the buyer’s assumption of the seller’s existing loan, or the
seller’s payoff of an existing loan; and
■■ a representative of the title insurance company.
Occasionally, the sales transaction has gone poorly and the buyers and sellers are
feeling very adversarial toward each other. In such a case, the two parties might
be seated in separate rooms in the settlement agent’s office and papers passed back
and forth through an intermediary.
Closing Agent or Closing Officer A closing agent may be a representative of
the title company, the lender, the real estate broker, or the buyer’s or seller’s attorney. Some title companies and law firms employ paralegal assistants who conduct
closings for their firms. In most cases, the role of the closing agent is to represent
the terms of the contract—not the personal interests of either the buyer or the
seller.
The Exchange The exchange is made when the parties are satisfied that everything is in order. The seller delivers the signed deed to the buyer, who accepts it.
All pertinent documents are then recorded in the correct order to ensure continuity of title. For example, if the seller pays off an existing loan and the buyer obtains
a new loan, the seller’s satisfaction of mortgage must be recorded before the seller’s
deed to the buyer. Because the buyer cannot pledge the property as security for the
new loan until ownership has been transferred, the buyer’s new mortgage or deed
of trust is recorded after the deed. Generally, there is no distribution of funds until
the documents have been recorded. In most cases, this means that the sellers do
not actually receive the proceeds from the sale for a day or two; likewise, any real
estate commissions due to the brokers are not paid immediately.
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Closing in Escrow
In an escrow closing, a third
party coordinates the closing
activities on behalf of the
buyer and the seller.
In an escrow closing, a disinterested third party is authorized to act as escrow
agent (escrow holder) and to coordinate the closing activities. The escrow agent
may be an attorney, a title company, a trust company, an escrow company, or the
escrow department of a lending institution.
Escrow Procedure After the sales contract is signed, the buyer and the seller
execute escrow instructions to the escrow agent. The selection of the escrow agent
is determined by negotiation, custom, or state law. The broker turns over the
earnest money to the escrow agent, who deposits it in a special trust, or escrow,
account.
The buyer and the seller deposit all pertinent documents and other items with the
escrow agent before the specified date of closing.
The seller usually deposits
■■ the deed conveying the property to the buyer,
■■ title evidence (abstract and attorney’s opinion of title, certificate of title,
title insurance, or Torrens certificate),
■■ existing hazard or homeowner insurance policies,
■■ a letter or mortgage reduction certificate from the lender stating the exact
principal remaining (if the buyer is assuming the seller’s loan),
■■ affidavits of title (if required),
■■ a payoff statement (if the seller’s loan is to be paid off), and
■■ other instruments or documents necessary to clear the title or to complete
the transaction.
The buyer deposits
■■ the balance of the cash needed to complete the purchase, usually in the form
of a certified check;
■■ loan documents (if the buyer secures a new loan);
■■ proof of hazard or homeowners insurance, including (where required) flood
insurance; and
■■ other necessary documents, such as inspection reports required by the lender.
Escrow Procedure The escrow agent has the authority to examine the title
evidence. When marketable title is shown in the name of the buyer and all other
conditions of the escrow agreement have been met, the agent is authorized to
disburse the purchase price to the seller, minus all charges and expenses. The
agent then records the deed and mortgage or deed of trust if a new loan has been
obtained by the purchaser.
If the escrow agent’s examination of the title discloses liens, a portion of the purchase price can be withheld from the seller. The withheld portion is used to pay
the liens to clear the title.
If the seller cannot clear the title, or if for any reason the sale cannot be consummated, the escrow instructions usually provide that the parties be returned to their
former status, as if no sale occurred. The escrow agent reconveys title to the seller
and returns the purchase money to the buyer.
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Internal Revenue Service (IRS) Reporting Requirements
Due to the Taxpayer Relief Act of 1997, it may not be necessary to file a Form
1099-S with the IRS if the capital gain is less than $250,000 for an individual or
$500,000 for a couple. Any gain from the sale of a home may be excluded if the
seller meets the ownership and use tests described in IRS Publication 523, Selling
Your Home:
To claim the exclusion, you must meet the ownership and use tests. This
means that during the 5-year period ending on the date of the sale, you must
have:
■■ Owned the home for at least 2 years (the ownership test), and
■■ Lived in the home as your main home for at least 2 years (the use test).
Certain real estate closings must be reported to the IRS on Form 1099-S. The
affected properties include sales or exchanges of
■■ land (improved or unimproved), including air space;
■■ an inherently permanent structure, including any residential, commercial, or
industrial building;
■■ shares in a cooperative housing corporation.
Information to be reported includes the sales price, the amount of property tax
reimbursement credited to the seller, and the seller’s Social Security number. If
the closing agent does not notify the IRS, the responsibility for filing the form
falls on the mortgage lender, although the brokers or the parties to the transaction
ultimately could be held liable.
Broker’s Role at Closing
Depending on local practice, the licensee’s role at closing can vary from simply collecting the commission to conducting the proceedings. In the states that
require an attorney’s participation, a licensee’s responsibility is essentially finished
as soon as the real estate contract is signed. Even so, most licensees continue to
be involved all the way through closing because it is also in their best interest
that the transactions move successfully and smoothly to a conclusion. On behalf
of their clients, licensees take care of all details so that the closing can proceed
smoothly. This may mean actively arranging for title evidence, surveys, appraisals,
and inspections or repairs related to structural conditions, water supplies, sewerage
facilities, or toxic substances.
Licensees should avoid recommending a single source for any inspection or testing services. If a buyer suffers any injury as a result of a provider’s negligence, the
licensee might also be named in any lawsuit. The better practice is to give clients
the names of several professionals who offer high-quality services. In addition,
licensees who receive any compensation or reward from a source they recommend
to a client must disclose such an arrangement to the client. Licensees must never
receive compensation from an attorney or a lender.
Although real estate licensees do not often conduct closing
proceedings, they usually attend. Often, the parties look to their agents for guidance,
assistance, and information during what can be a stressful experience. Licensees
must be thoroughly familiar with the process and the procedures involved in preparing a closing statement, which includes the expenses and prorations of costs to close
the transaction.
I N
P R A C T I C E
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The Texas Promulgated Contract forms frequently say that possession will be at
closing and funding. If that is the agreement, the buyer will receive the keys when
the title company is funding, or writing checks to pay expenses to, the seller, brokers, and so on. Funding is rarely on the same day as closing.
The Dodd–Frank Wall Street Reform Act and the Consumer
Financial Protection Bureau
As the White House explains,
In the fall of 2008, a financial crisis of a scale and severity not seen
in generations left millions of Americans unemployed and resulted
in trillions in lost wealth. Our broken financial regulatory system was
a principal cause of that crisis. It was fragmented, antiquated, and
allowed large parts of the financial system to operate with little or no
oversight. And it allowed some irresponsible lenders to use hidden
fees and fine print to take advantage of consumers.1
In 2010 the Dodd–Frank Wall Street Reform and Consumer Protection Act was
signed into law. The White House continues,
The most far reaching Wall Street reform in history, the Dodd–Frank
Act will prevent the excessive risk-taking that led to the financial
crisis. The law also provides common-sense protections for American
families, creating [a] new consumer watchdog to prevent mortgage
companies and pay-day lenders from exploiting consumers.2
The goal, the White House states, is “protecting American families from unfair,
abusive financial practices.”3
To consolidate accountability and responsibility, the Consumer Financial Protection Bureau (CFPB) was created. The CFPB regulates all consumer financial products, including mortgages, and has jurisdiction over enforcement of the Truth in
Lending Laws (TILA) and the Real Estate Settlement Procedures Act (RESPA).
The stated goals of CFPB will change the way we do business in the future. Their
goals include the following:
■■ Easier-to-use mortgage disclosure forms
■■ Improved consumer understanding
■■ Aiding in comparison shopping
■■ Preventing surprises at the closing table, also known as Know Before You Owe
As a part of the Know Before You Owe goals, CFPB created two new forms to help
consumers:
■■ The LOAN ESTIMATE must be provided to the consumer within three
days after receiving the loan application and replaces The Good Faith Estimate (GFE) and initial Truth-in-Lending (TIL).
■■ The CLOSING DISCLOSURE must be delivered to the consumer three
days prior to closing. It replaces the HUD-1 Settlement Statement.
1
2
3
“Wall Street Reform: The Dodd–Frank Act,” The White House, https://www.whitehouse
.gov/economy/middle-class/dodd-frank-wall-street-reform.
Ibid.
Ibid.
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Each of the new documents has certain tolerances if changes occur after the document is delivered.
The Loan Estimate has a zero tolerance for lender or broker charges, fees charged
by an affiliate to the creditor, fees charged by service providers selected by creditors, and charges where consumers are not permitted to shop outside. There is a
10% limit on all other third-party charges. If any changes exceed these limits,
the Loan Estimate must be reissued within three business days, which resets the
tolerances.
The Closing Disclosure will have to be reissued if, after it has been sent to the
buyer, the lender increases the annual percentage rate (APR) by more than 1/8%,
changes the loan product, or adds a pre-payment penalty to the loan. When it is
reissued, it triggers another three-business-day waiting period until closing.
REAL ESTATE SETTLEMENT PROCEDURES ACT (RESPA)
The Real Estate Settlement Procedures Act (RESPA) is a federal consumer law
that requires certain disclosures about the mortgage and settlement process and
prohibits certain practices, such as kickbacks and referral fees, that can increase
settlement costs for homebuyers.
RESPA regulations apply to first-lien residential mortgage loans made to finance
the purchases of one- to four-family homes, cooperatives, and condominiums, for
either investment or occupancy, as well as second or subordinate liens for home
equity loans when a purchase is financed by a federally related mortgage loan.
Federally related loans can be loans made by banks, savings and loan associations,
or other lenders whose deposits are insured by federal agencies; loans insured by
the Federal Housing Administration (FHA) and guaranteed by the Department
of Veterans Affairs (VA); loans administered by HUD; and loans intended to be
sold by the lenders to Fannie Mae, Ginnie Mae, or Freddie Mac. RESPA, formerly
administered by HUD, is now administered by the Consumer Financial Protection Bureau (CFPB).
RESPA does not apply to the following settlements:
■■ Loans on large properties (more than 25 acres)
■■ Loans for business or agricultural purposes
■■ Construction loans or other temporary financing
■■ Vacant land (unless a dwelling will be placed on the lot within two years)
■■ A transaction financed solely by a purchase-money mortgage taken back by
the seller
■■ An installment contract (contract for deed)
■■ A buyer’s assumption of a seller’s existing loan (if the terms of the assumed
loan are modified, or if the lender charges more than $50 for the assumption,
the transaction is subject to RESPA regulations)
RESPA prohibits certain practices that increase the cost of settlement services:
■■ Section 8 prohibits kickbacks and fee-splitting for referrals of settlement ser-
vices, and unearned fees for services not actually performed. Violations are
subject to criminal and civil penalties, including fines up to $10,000 and/or
imprisonment up to one year. Consumers may privately pursue a violator in
court; the violator may be liable for an amount up to three times the amount
of the charge paid for the service.
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■■ Section 9 prohibits sellers from requiring that homebuyers buy title insur-
ance from a particular company. Buyers may sue the seller for such a violation; violators are liable for up to three times the amount of all charges paid
for the title insurance.
■■ Section 10 prohibits lenders from requiring excessive escrow account deposits, money set aside to pay taxes, hazard insurance, and other charges related
to the property.
To make it easier for borrowers to understand costs, lenders are required to provide
the Loan Estimate, which clearly discloses key loan terms and closing costs. More
importantly, most of these disclosed costs cannot vary greatly between the time
that the Loan Estimate is issued and the Closing Disclosure is received.
I N P R A C T I C E Although RESPA’s requirements are aimed primarily at lenders, real estate licensees fall under RESPA when they refer buyers to particular lenders, title companies, attorneys, or other providers of settlement services. Licensees
who offer computerized loan origination (CLO) are also subject to regulation. Remember: Buyers have the right to select their own providers of settlement services.
Disclosure Requirements
Lenders and settlement agents have the following disclosure obligations at the
time of loan application and loan closing or within three business days of receiving the loan application. If the lender denies the loan within three days, then
RESPA does not require that the lender provide the Loan Estimate.
The only fees that the lender may collect before the applicant receives the
Loan Estimate are for a credit report and appraisal. Once the Loan Estimate is
issued, lenders are committed and may only modify the Loan Estimate in specific
instances.
If certain information or circumstances change after the original Closing Disclosure is issued, then a new Closing Disclosure must be issued. Issuing a new Closing
Disclosure triggers a new three-day waiting period; in this case, closing may not
occur until after three days have passed.
If there is a change to any one of three very specific and very important items, the
lender must provide another three business days to review the updated disclosure.
Following are the only three changes that would require a new three-day review
period:
■■ Increasing the annual percentage rate (APR) by more than one-eighth of a
percentage point for a fixed-rate loan or one-fourth of a percentage point for
an adjustable-rate loan (decreasing the interest rate or fees doesn’t cause a
delay)
■■ The addition of a prepayment penalty
■■ Changes in the loan product (from a fixed-rate to an adjustable-rate loan, for
example)
However, many things can change in the days leading up to closing that won’t
require a new three-day review period, including typos on the forms, problems
discovered on a walk-through, and most changes to payments made at closing,
including changes that require seller credits.
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Mortgage Servicing Disclosure Statement This statement tells the borrower whether the lender intends to service the loan or to transfer it to another
lender. It will also provide information about resolving complaints.
The last page of the Loan Estimate has information that consumers can use to
compare different loans and terms to aid in price shopping. The lender is responsible for the accuracy of the Loan Estimate and the actual costs that the lender
charges on the Closing Disclosure.
Closing Disclosure RESPA requires that the Closing Disclosure itemize all
charges that are normally paid by a borrower and a seller in connection with
settlement, whether required by the lender or another party or paid by the lender
or any other person (see Figure 9.5). Charges required by the lender that are paid
before closing are indicated as paid outside of closing (POC). The third page of
the Closing Disclosure provides for a comparison of the original Loan Estimate to
the actual charges appearing on the Closing Disclosure.
RESPA prohibits lenders from requiring borrowers to deposit amounts in escrow
accounts for taxes and insurance that exceed certain limits, thus preventing the
lenders from taking advantage of the borrowers. While RESPA does not require
that escrow accounts be set up, certain government loan programs and some lenders require escrow accounts as a condition of the loan. RESPA places limits on the
amounts that a lender may require: on a monthly basis, the lender may require
only one-twelfth of the total of the disbursements for the year, plus an amount
necessary to cover a shortage in the account. No more than one-sixth of the year’s
total disbursements may be held as a cushion (a cushion is not required). Once a
year, the lender must perform an escrow account analysis and return any amount
over $50 to the borrower. By law, borrowers have the right to inspect a completed
Closing Disclosure three business day before the closing. Lenders must retain
these statements for two years after the closing date. In addition, state laws generally require that licensees retain all records of a transaction for a specific period. In
Texas records must be maintained by the broker for four years.
Kickbacks and Referral Fees RESPA prohibits the payment of kickbacks, or
unearned fees, in any real estate settlement service. It prohibits referral fees when
no services are actually rendered. The payment or receipt of a fee, a kickback, or
anything of value for referrals for settlement services includes activities such as
mortgage loans, title searches, title insurance, attorney services, surveys, credit
reports, and appraisals.
Controlled Business Arrangements
To streamline the settlement process, a real estate firm, title insurance company,
mortgage broker, home inspection company, or even a moving company may agree
to offer a package of services to consumers, a system called a controlled business
arrangement (CBA). RESPA permits a CBA as long as a consumer is clearly
informed of the relationship among the service providers, that participation is
not required, that other providers are available, and that the only thing of value
received by one business entity from others, in addition to permitted payments
for services provided, is a return on ownership interest or franchise relationship.
Fees must be reasonably related to the value of the services provided and not be
fees exchanged among the affiliated companies simply for referring business to
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one another. This referral-fee prohibition may be a particularly important issue for
licensees who offer computerized loan origination (CLO) services to their clients
and customers.
PRORATIONS
Most closings involve the division of financial responsibility between the buyer
and the seller for such items as loan interest, taxes, rents, fuel, and condominium
or homeowners association fees. These allowances are called prorations. Prorations are necessary to ensure that expenses are divided fairly between the seller
and the buyer. For example, the seller may owe current taxes that have not yet
been billed; the buyer would want a credit from the seller at the closing. When
taxes must be paid in advance, the seller is entitled to a rebate at the closing. If the
buyer assumes the seller’s existing mortgage or deed of trust, the seller usually owes
the buyer an allowance for accrued interest through the date of closing.
The Arithmetic of Prorating
Accurate prorating involves the following four considerations:
■■ Nature of the item being prorated
■■ Whether the item is accrued and requires the determination of an earned
amount
■■ Whether the item is prepaid and requires the determination of an unearned
amount (i.e., a refund to the seller)
■■ What arithmetic processes must be used
The computation of a proration involves identifying a yearly charge for the item
to be prorated, then dividing by 12 to determine a monthly charge for the item.
Also, it is usually necessary to identify a daily charge for the item by dividing the
monthly charge by the number of days in the month. These smaller portions are
then multiplied by the number of months or days in the prorated period to determine the accrued or unearned amount that will be figured in the settlement.
The rules or customs governing the computation of prorations for the closing of
a real estate sale vary widely from state to state. The following are some general
guidelines for preparing the closing statement:
■■ In most states (including Texas), the seller owns the property on the day of
closing, and prorations or apportionments are usually are made up to and
including the day of closing. A few states specify that the buyer owns the
property on the closing date. In that case, adjustments are made as of the day
preceding the day on which title is closed.
■■ Mortgage interest, general real estate taxes, water taxes, insurance premiums,
and similar expenses are usually computed by using 360 days in a year and
30 days in a month. However, the rules in some areas provide for computing
prorations on the basis of the actual number of days in the calendar month
of closing. The agreement of sale should specify which method will be used.
■■ Accrued or prepaid general real estate taxes are usually prorated at the closing. When the amount of the current real estate tax cannot be determined
definitely, the proration is usually based on the last obtainable tax bill.
■■ Special assessments for municipal improvements such as sewers, water mains,
or streets are usually paid in annual installments over several years, with
annual interest charged on the outstanding balance of future payments. The
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seller normally makes the current payments, and the buyer assumes all future
payments. The special assessment installment generally is not prorated at
the closing. A buyer may insist that the seller allow the buyer a credit for the
seller’s share of the interest to the closing date. The agreement of sale may
address the manner in which special assessments will be handled at closing.
■■ Rents are usually adjusted on the basis of the actual number of days in the
month of closing. The seller customarily receives the rents for the day of
closing and pays all expenses for that day. If any rents for the current month
are uncollected when the sale is closed, the buyer often agrees by a separate
letter to collect the rents, if possible, and remit the prorated share to the
seller.
■■ Security deposits made by tenants to cover the last month’s rent of the lease
or to cover the cost of repairing damage caused by the tenant are generally
transferred by the seller to the buyer.
Real Estate Taxes Proration of real estate taxes varies widely depending on
how the taxes are paid in the area where the real estate is located. In some states,
real estate taxes are paid in advance—that is, if the tax year runs from January 1
to December 31, taxes for the coming year are due on January 1. In this case, the
seller, who has prepaid a year’s taxes, should be reimbursed for the portion of the
year remaining after the buyer takes ownership of the property. In other areas,
taxes are paid in arrears, on December 31 for the year just ended. In this case, the
buyer should be credited by the seller for the time the seller occupied the property.
Sometimes, taxes are due during the tax year, partly in arrears and partly in
advance; sometimes they are payable in installments. Tax payments can even be
more complicated if city, state, school, and other property taxes start their tax
years in different months.
Mortgage Loan Interest On almost every mortgage loan, the interest is paid
in arrears. The buyer and the seller must understand that a mortgage payment
due on June 1, for example, includes interest due for May. Thus, the buyer who
assumes a mortgage on May 31 and makes the June payment pays for the time the
seller occupied the property and should be credited with a month’s interest. On
the other hand, the buyer who places a new mortgage loan on May 31 may be
pleasantly surprised to learn that the first mortgage payment is not due for another
month.
SUMMARY
The transaction process from contract to closing involves many steps. Major categories are as follows:
■■ Loan approval:
—— Application
—— Credit report and score
■■ Appraisal
■■ Inspection:
—— Report
—— Resolution
■■ Title work:
—— Chain of title
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—— Abstract of title
—— Cloud on the title
■■ Preparation for closing:
—— Closing agent
—— Buyer
—— Seller
Closing (settlement and transfer) is the point at which ownership of a property is
transferred in exchange for the selling price.
To complete the transaction, the buyer requires the following:
■■ Title evidence—a current abstract of title with opinion of title from the
buyer’s attorney or title commitment from the title insurance company
■■ Seller’s deed
■■ Affidavit of title by the seller and documents showing the removal of prior
encumbrances
■■ Mortgage reduction certificate from the lender, if the buyer is assuming the
loan
■■ Survey and the results of required inspections
■■ Leases, if tenants reside on the premises
■■ Successful final property inspection (walk-through)
■■ Closing Disclosure showing the amount and distribution of funds
To complete the transaction, the seller requires the following:
■■ Payoff statement from the seller’s lender noting the amount owed
■■ Evidence that the buyer has the necessary funds
■■ Closing statement showing the distribution of funds
Depending on state law and local custom, closing may be conducted through a
■■ licensed escrow company, in which case the parties may execute documents
separately and never meet, or
■■ a face-to-face meeting of the parties at the escrow company, title company,
lender’s office, or attorney’s office.
An escrow holder (escrow agent) is a disinterested third party authorized to coordinate the closing activities.
The Internal Revenue Service (IRS) may require completion and submission of
the Form 1099-S statement of income to the seller showing the seller’s Social
Security number. The seller may be exempt from paying capital gains tax under
the Taxpayer Relief Act of 1997.
The Real Estate Settlement Procedures Act (RESPA) is a federal law enacted to
protect consumers in the settlement process as follows:
■■ Requires accurate and timely information about the actual costs of a
transaction
■■ Eliminates kickbacks and other referral fees
■■ Prohibits lenders from requiring excessive escrow account deposits
RESPA does not apply to a transaction financed solely by a purchase-money mortgage taken back by a seller, installment contracts (contract for deed), or a buyer’s
assumption of a seller’s existing loan.
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RESPA requires that lenders and settlement agents provide a
■■ special information booklet produced by HUD to every person from whom
they receive or for whom they prepare a loan application (except for
refinancing),
■■ Loan Estimate of settlement costs to the borrower no later than three business days after receiving a loan application, and
■■ Closing Disclosure to the borrower and the seller that itemizes all charges to
be paid in connection with closing.
A Closing Disclosure involves an accounting of the amounts paid by or received
by the parties, as follows:
■■ Debit (give) is a charge that must be paid by the buyer or the seller at
closing.
■■ Credit (receive) is the amount entered in favor of the buyer or the seller.
■■ In most instances, a debit to one party is a credit to the other party.
■■ Certain charges are prorated, divided between the buyer and the seller, in
one of two ways:
—— Yearly charge is divided by a 360-day year (banking year), or 12 months
of 30 days each.
—— Yearly charge is divided by a 365-day year (366 days in leap year) to
determine the daily charge and the actual number of days in the proration period, and then the number of days is multiplied by the daily
charge.
■■ In most states, the charges are prorated as of the date of closing, with the
seller being responsible for the date of closing.
UNIT 9 REVIEW QUESTIONS
1. Which statement is TRUE of real estate closings in most states?
a. Closings are generally conducted by real estate salespersons.
b. The buyer usually receives the rents for the day of closing.
c. The buyer must reimburse the seller for any title evidence provided by the seller.
d. The seller usually pays the expenses for the day of closing.
2. All of the following are responsibilities of the closing agent EXCEPT
a. ordering the title search and the survey.
b. arranging for homeowners insurance.
c. obtaining title insurance policy for the lender.
d. preparing the deed and the Closing Disclosure.
3. All encumbrances and liens shown on the report of title, other than those waived or agreed to by the
purchaser and listed in the contract, must be removed so that the title can be delivered free and clear. The
removal of such encumbrances is typically the duty of the
a. buyer.
b. seller.
c. broker.
d. title company.
4. The appraisal method most likely used on a specialty-use building, like a church, is the
a. cost approach.
b. income method based on the collections only.
c. comparative method based on the sale of other churches in the city.
d. church income
andreproduction
collectionormethod.
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5. The Uniform Residential Loan Application requires the borrower(s) to complete the form with all of the
following information EXCEPT
a. the value of a paid-for boat.
b. funds for the down payment and closing costs.
c. credit score.
d. a legal description of the property being purchased.
6. According to the Taxpayer’s Relief Act of 1997, which of the following is TRUE of a couple that is selling
their home where they have lived for the last 11 years?
a. They will only pay capital gains tax at the lowest rate.
b. They will avoid capital gains tax if they purchase another home within six months.
c. They may avoid capital gains tax if one or both of them is 62 years old.
d. They may avoid capital gains tax up to $450,000.
7. A mortgage reduction certificate is executed by
a. an abstract company.
b. an attorney.
c. a lending institution.
d. a grantor.
8. Which charge noted on the Closing Disclosure would require a new Closing Disclosure and a three-day
waiting period before the loan can close?
a. Cost of settlement services when the lender selects the provider
b. The addition of a prepayment penalty
c. Cost of settlement services when the borrower selects the provider from the list provided by the lender
d. Cost of homeowners insurance
9. All of the following are tasks to be done by the buyer in preparation for closing EXCEPT
a. arrange for homeowners insurance.
b. contact utilities to start service.
c. schedule repairs needed as result of home inspection.
d. obtain cashier’s check for funds needed at closing.
10. Which entity implemented Know Before You Owe?
a. HUD
b. Consumer Financial Protection Bureau
c. Texas Real Estate Commission
d. Internal Revenue Service
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10
U N I T
■■
LEARNING OBJECTIVES
Common Contract
Mistakes
When you have completed this unit, you will be able to
■■ describe issues with the identification of the parties and the property in a
sales contract;
■■ describe issues in the sales contract regarding checkboxes, signatures, effec-
tive dates, and addenda;
■■ discuss the proper and improper use of the Special Provisions paragraph of
the sales contract;
■■ explain what makes property real or personal and the need to address these
issues in the sales contract; and
■■ describe the terms marketable title and cloud on the title.
INTRODUCTION
Although TREC forms were created to prevent contract mistakes, fulfill regulatory requirements, protect the rights of buyers and sellers, and protect licensees
from taking part in the unauthorized practice of law, the system is not infallible.
Regardless of their education, experience, or hours of preparation, new and experienced licensees alike commonly make mistakes when filling out sales contracts,
contingencies, amendments, and addenda. Anyone with several years of experience in real estate can probably add many more examples to the list. For the listing broker who will be receiving the original offers, this unit can identify red flags
to look for on behalf of the seller.
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Verbal Offers
Some agents believe that it is not correct to present verbal offers. While the statute of frauds says that a contract must be in writing in order to be enforceable,
a verbal offer isn’t yet a contract. Remember that all offers are to be presented,
whether verbal or written. A seller will accept a good offer, regardless of whether
it is verbal or written.
CONTRACT EXAMPLES
Different sections of a TREC-promulgated contract—including the mistakes—are
featured here, followed by recommendations for improvement.
Naming the Parties
1. PARTIES: The parties to this contract are Mrs. Portner
(Seller) and Kristina Kay Wright and Benjamin Charles Wright
(Buyer).
Seller agrees to sell and convey to Buyer and Buyer agrees to buy from Seller the Property defined
below.
Mistake #1: The seller’s legal name is not Mrs. Porter. Include the seller’s full
legal name. The name used here should reflect the name on the property’s title
(if the name was listed correctly when the seller took title to the property). In
addition, because Texas is a community property state, the licensee will need to
furnish marital status. To be accurate, the seller should be listed as “Carol Anne
Porter, a single person.”
Mistake #2: The buyers’ marital status is also missing. The buyers should be listed
as “Kristina Kay Wright and husband Benjamin Charles Wright.”
Naming the Property
2. PROPERTY: The land, improvements and accessories are collectively referred to as the “Property”.
A. LAND: Lot 128
Block 17
, Section of Shady Hills
Addition, City of Lakeview
, County of Smith
,
Texas, known as 12690 Pinehall Court 76544
(address/zip code), or as described on attached exhibit.
B. IMPROVEMENTS: The house, garage and all other fixtures and improvements attached to the
Mistake: Legal description is incomplete because the section number is not provided. Agents frequently fail to include the section number with the subdivision
name. To be accurate, the subdivision should be listed as “Section 4 of Shady
Hills.” Remember, a street address is never a sufficient legal description.
Checkboxes within Paragraphs
the Title Company and Buyer’s lender(s). (Check one box only)
5
days after the effective date of this contract, Seller shall furnish to Buyer
and Title Company Seller's existing survey of the Property and a Residential Real Property
Affidavit promulgated by the Texas Department of Insurance (T-47 Affidavit). If Seller
fails to furnish the existing survey or affidavit within the time prescribed, Buyer
shall obtain a new survey at Seller's expense no later than 3 days prior to Closing
Date. If the existing survey or affidavit is not acceptable to Title Company or Buyer's
lender(s), Buyer shall obtain a new survey at Seller's Buyer's expense no later than 3
days prior to Closing Date.
(2) Within
days after the effective date of this contract, Buyer shall obtain a new
(1) Within
Mistake: In the event that the existing survey provided by the seller within five
days of the effective date of the contract is not acceptable to the title company
or the buyer’s lenders, it is unclear which party (buyer or seller) is responsible for
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Unit 10 Common Contract Mistakes
217
paying for the new survey. The paragraphs of the TREC-promulgated contracts
contain checkboxes that can easily be overlooked; however, overlooking these
items can cause delays in the transactions and contention between the parties, not
to mention make the licensee look incompetent.
Licensees should become familiar with all the checkbox options in the TRECpromulgated forms, including in the Possession paragraph, where the licensee
needs to indicate whether possession will be granted “upon closing and funding”
or “according to a temporary residential lease form.” In addition, if possession does
not happen “upon closing and funding,” the licensee will need to use the appropriate TREC temporary lease and indicate that in paragraph 22 of the contract.
Special Provisions
Mistake #1: Remove A, as licensees should not structure “subject to” or “contingent upon” provisions. This falls outside of “factual statements.”
Mistake #2: Remove B, as TREC promulgates a form for this purpose.
Mistake #3: Remove C, as it is addressed in paragraph 23 of the contract.
When the parties need to add factual statements or business details to their agreement, they may use paragraph 11. When the parties want to define legal rights
and remedies, they should seek competent legal advice. Licensees are prohibited
from including legal rights or remedies in paragraph 11, but buyers and sellers and
their attorneys are not. A factual statement states what someone will or will not
do. A legal right or remedy states what will happen if someone does or does not do
a particular act. An allowable statement under this paragraph might say, “Seller to
leave swing set in backyard.”
Default
under this contract.
15. DEFAULT:
If Buyer fails to comply with this contract, Buyer will be in default, and Seller may
(a) enforce specific performance, seek such other relief as may be provided by law, or both,
or (b) terminate this contract and receive the earnest money as liquidated damages, thereby
releasing both parties from this contract. If Seller fails to comply with this contract, Seller will
be in default and Buyer may (a) enforce specific performance, seek such other relief as may
be provided by law, or both, or (b) terminate this contract and receive the earnest money,
thereby releasing both parties from this contract.
16. MEDIATION:
It is the policy of the State of Texas to encourage resolution of disputes
The following is typical of the Default paragraph in most contracts. The only
time this paragraph gets really looked at is when the contract is falling out and
everyone wants to point the finger of guilt at everyone else. When either party is
threatening to walk out on the contract, a careful reading of the default section
may make them more inclined to try to work out the problem.
Signatures and Effective Date
All sales contracts have space at the end for the signatures of all parties and a
space for the effective date, to be filled out by the broker. All too often, effective
dates are not entered or signatures or initials are missing on the sales contract or
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one or more of the addenda. Point to remember: a soon-to-be ex-spouse is still
required to sign the sales contract to avoid any possible future title claims. This is
why it is so important to get that signature on the listing agreement as soon as it is
taken in order to avoid a confrontation at the time an offer is received.
The Electronic Signatures in Global and National Commerce Act (ESIGN) and
the Uniform Electronic Transactions Act (UETA) provide that “signatures” made
via electronic means are just as binding as hand-written ones. To use electronic
signatures in a real estate transaction in Texas, both parties must agree to it in an
electronic consent form.
Addenda
Any addenda that are to be a part of the contract must be identified in paragraph
22 of the TREC-promulgated contracts (see Unit 6). Do not indicate in paragraph
22 that an addendum is being used and then not attach one, and do not attach an
addendum without indicating in paragraph 22 that one is being used.
Using the TREC-Promulgated Contract Form for a 1031
Exchange
It is sometimes tempting to use a One to Four Family Residential Contract to purchase the up-leg property when someone is intending to perform a 1031 exchange.
While 1031 exchanges are increasing in popularity now that the capital gains
taxes have increased, care must still be given to the form of the exchange. One of
the key words in the IRS Code is intent to exchange, which presupposes that it is
manifested in the original paperwork. If the One to Four Family Residential Contract must be used due to time or other considerations, then paragraph 11 (Special
Provisions) will be used to accomplish the objective. The seller or a lawyer must
prepare language similar to the following:
The labeled buyer in this contract wishes to effect an IRS Section 1031
exchange and, therefore, this contract is not to be considered a contract to
purchase, but rather a binder on terms and conditions that the exchanger
(buyer) will agree to in a subsequent exchange agreement. The exchanger
warrants to the seller that there will be no additional expense or delay as a
result of the exchange.
The two parts should be very clear in their purpose.
1. The buyer now has the intent developed initially, and this will be consistent
throughout the transaction.
2. The seller understands that there will be no additional expense or delay.
Note that many residential agents and some sellers may hesitate at being involved
in something they have never done before. The procuring agent should take great
care to provide context to the contract with the listing agent prior to submission
of the offer.
Some real estate practitioners will want to follow strict deeding practices, while
others will consider “pool” deeding acceptable. If formal procedures are to be followed, the seller should be informed that they will, in fact, come into title to
accomplish the exchange. Now is the time for the seller’s agent to recommend
that the seller get an attorney.
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Unit 10 Common Contract Mistakes
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COMMON AREAS OF CONCERN
Real or Personal
There is probably more frustration, argument, and litigation over the matter of
real versus personal property and whether or not something conveys with the
property than over any other area of selling real estate. For the peace of mind of
everyone involved, the listing agent needs to take special care in listing items that
do convey and those that do not convey. On the other hand, the selling agent
should carefully list all items that the purchaser wants to have included in the
sale, regardless of whether it is real property or not. Technically, the dining room
chandelier is a fixture—but when it was great-grandma’s passed down through
generations, it becomes very personal.
Usually the problem does not become evident until the final walk-through shortly
before the closing. Get a group of listing agents together, and they can go on for
hours with stories about missing items they have replaced (often at their own cost)
in order to keep the settlement on track. Here are some examples:
■■ In the yard. The six prize rose bushes the seller couldn’t bear to part with,
the budding magnolia tree planted two years ago in memory of the owner’s
mother, and freshly planted tomato plants in the garden are all real property.
■■ In the kitchen. The listing showed that a refrigerator conveyed. When the
purchaser first visited the house, a large side-by-side refrigerator/freezer was
solidly in place. However, at walk-through, the big fancy appliance was gone
and had been replaced with a small, 15-year-old refrigerator that had been in
the garage. The listing only said “refrigerator” and refrigerators are technically personal property (can be moved) so, after that experience, the buyer
agent started listing serial numbers for all appliances expected to be left in
the house.
■■ In the dining room. Corner cupboards in the dining room looked to be permanent attachments, but when the buyers returned to their new home after
settlement, the cupboards were gone. Neither the listing nor the contract
addressed the cupboards in any way. Buyers assumed they were part of the
real property; sellers assumed they were movable personal property. Agents
are shopping for replacements.
Title Questions
Most contracts clearly state that the seller is responsible for providing marketable
title to the property. As mentioned before, the term marketable means a title that
has no defects that could carry over as a problem for the new owners at whatever
time they decide to sell.
Sometimes the cloud on the title is minor: a misspelling of a grantor’s name, an
incorrect date, or a slight error in the legal description. In more serious cases, such
as a missing name of the grantor or a gap in the chain of title, it may be necessary
to file a suit for quiet title. This is not necessarily a huge problem, but court action
always takes time. Occasionally, the cloud is more like a thunderstorm, as was the
case described below.
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E X A M P L E Buyers and sellers had finalized a sales contract, and the
transaction was in process. A routine title search discovered that the county had an
easement across one side of the property to provide access to the sewer line. Normally, this would not be an issue, but unfortunately, that easement went right under
one side of the in-ground swimming pool. Despite the fact that county engineers said
that they would never have any need to make use of the easement—that, in fact, they
had a totally different way of handling sewer backup problems without digging up the
area—the county legal department was not willing to sign off on it. The title company
was actually willing to “insure over” the defect, but that might have left the buyers with
a potential problem in the future.
F O R
The buyers produced an estimate from a landscaping company for what it would cost
to dig out the pool and replace all the landscaping: close to $50,000. They asked the
sellers to reduce the sales price of the house by that much. At first, the sellers were
ready to let the contract go into default, but eventually they came to an agreement with
the buyers to reduce the sales price by $25,000 and the sale did go to settlement.
Ironically, when the sellers purchased the property from the original owners, the problem of the easement never came up, although it certainly would have been in place at
that time. Was the survey faulty? Or not done? Did the original title company neglect
to check for easements? Should title insurance have covered this issue? If the sellers
refused to cooperate with the buyers request for a reduction in price, could the buyers
have sued them for specific performance? Could the buyers be forced to accept title
insurance that had insured over the defect? There are many questions and no easy
answers.
Possession
Paragraph 10 of the One to Four Family Residential Contract can be challenging
when possession is upon closing and funding. Occasionally, closing does not occur
in a timely manner, and sometimes the closing doesn’t occur at all. Examples of
potential closing delays which have occurred one day prior to closing include the
following:
■■ Late appraisal that did not make contract price
■■ Specified repairs were not made, and the final walk-through was a
disappointment
■■ Buyer became unemployed
■■ Underwriter rejected the loan at the last minute
A delayed or cancelled closing can affect buyers, sellers, movers, and agents. If
timing is critical to one of the parties, then the risk must be balanced, which
means the downside for one party is balanced with risk (financial loss) on the
other side.
SUMMARY
Even when preprinted forms are used for sales contracts, there are many opportunities for mistakes to be made. Some of the most common are
■■ not using complete legal names of the parties,
■■ not providing an adequate legal description,
■■ not checking all applicable boxes in the contract,
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Unit 10 Common Contract Mistakes
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■■ inserting factual statements in the Special Provisions paragraph, and
■■ including addenda without indicating that in paragraph 22, or indicating the
use of addenda in paragraph 22 without including the addenda.
Default remedies need to be explained to both buyer and seller.
Signatures, initials, and an effective date are required on the contract, and signatures and initials are required on all addenda and amendments.
Other common areas of concern are
■■ handling real and personal property, and
■■ problems with clear title.
UNIT 10 REVIEW QUESTIONS
1. Which is the BEST way to list the seller’s name on the contract?
a. Will Jones
b. Billy Jones
c. William J. Jones
d. W. J. Jones
2. A husband and wife are selling their home. They are separated, and she actually lives in another town. It is
still important to have her signature on
a. the listing agreement.
b. the sales contract.
c. both the listing agreement and the sales contract.
d. neither the listing agreement nor the sales contract.
3. All of the following are acceptable for a legal description of the property EXCEPT
a. an exhibit attached to the contract.
b. 4092 Terrace Ct., Dallas, TX 75211.
c. Lot 140 Block 3, Section 2 of Wedgewood Terrace Addition, City of Lakeview, County of Smith,
Texas, known as 12690 Pinehall Court 76544.
d. Lot 64 Block 83, Section 2 of Friendly Hills Addition, City of Austin, County of Travis, Texas, known
as 2365 Veterans Boulevard 78711.
4. Any addenda to be attached to the contract
a. should be listed in the Special Provisions paragraph.
b. do not need to be signed if the contract has already been fully executed.
c. should be signed electronically.
d. should be signed by the parties and listed in paragraph 22 of the contract.
5. All of the following are real property EXCEPT
a. chandelier.
b. built-in dishwasher.
c. storm door.
d. freestanding workbench.
6. All of the following are personal property EXCEPT
a. oriental rug in dining room.
b. wall-to-wall carpet in bedroom.
c. refrigerator in the kitchen.
d. bookcase in the living room.
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7. A careful review of the default section of a sales contract can
a. support a buyer in deciding to walk away from the contract.
b. encourage a seller to refuse to remedy a defect in the title.
c. help either a buyer or seller understand the financial impact of default.
d. help place the blame on the other party.
8. What does it mean when a property has marketable title?
a. The property is worth more than $250,000.
b. The property has been properly insured during the seller’s ownership of the property.
c. The property title is free of defects.
d. The property will likely sell within four to six weeks.
9. Which of the following is an example of a cloud on the title?
a. An error in the property’s legal description
b. A dispute of the property’s legal ownership
c. A misspelling of a grantor’s name
d. All of these
10. The Uniform Electronic Transactions Act (UETA) provides that
a. sales contracts must be signed electronically after December 31, 2012.
b. handwritten signatures are no longer valid.
c. signatures by electronic means are as binding as handwritten ones.
d. electronic signatures only apply to fax copies.
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Glossary
abstract of title The condensed history of the recorded
ownership of a particular parcel of real estate, consisting
of a summary of the original grant and all subsequent conveyances and encumbrances affecting the property and a
certification by the abstractor that the history is complete
and accurate.
alienation clause The clause in a mortgage or deed of
trust stating that the balance of the secured debt becomes
immediately due and payable at the lender’s option if the
property is sold by the borrower. In effect, this clause prevents the borrower from assigning the debt without the
lender’s approval.
acceleration clause The clause in a mortgage or deed
of trust that can be enforced to make the entire debt due
immediately if the borrower defaults on an installment
payment or other obligation.
amendment A change to the existing content of a contract (i.e., if words or provisions are added to or deleted
from the body of the contract). It must be initialed by all
parties.
acceptance An expression of intent to be bound by the
terms and conditions of an offer. To bind the agreement,
the acceptance must be communicated to the person making the offer. An offer pertaining to real estate must be
made in writing and accepted in writing.
amortized loan A loan in which the principal, as well
as the interest, is payable in monthly or other periodic
installments over the term of the loan.
accretion The increase or addition of land by the deposit
of sand or soil washed up naturally from a river, lake, or sea.
acknowledgment A formal declaration made before a
duly authorized officer, usually a notary public, by a person
who has signed a document.
actual notice Express information or fact; that which is
known; direct knowledge.
ad valorem tax A tax levied according to value, generally used to refer to real estate tax. Also called the general
tax.
addendum Any provision added to an existing contract
without altering the content of the original. It must be
signed by all parties.
adjustable-rate mortgage (ARM) A loan characterized
by a fluctuating interest rate, usually one tied to a bank or
savings and loan association cost-of-funds index.
adverse possession The actual, open, notorious, hostile,
and continuous possession of another’s land under a claim
of title. Possession for a statutory period may be a means of
acquiring title.
affidavit of title A written statement, made under oath
by a seller or grantor of real property and acknowledged by
a notary public, in which grantors (1) identify themselves
and indicate marital status, (2) certify that since the examination of the title, on the date of the contract no defects
have occurred in the title, and (3) certify that they are in
possession of the property (if applicable).
annexation Process of converting personal property into
real property.
annual percentage rate (APR) The relationship of the
total finance charges associated with a loan. This must be
disclosed to borrowers by lenders under the Truth in Lending Act.
appraisal An estimate of the quantity, quality, or value
of something. The process through which conclusions of
property value are obtained; also refers to the report that
sets forth the process of estimation and conclusion of value.
appurtenance A right, privilege, or improvement
belonging to, and passing with, the land; “runs with the
land.”
area preference People’s desire for one area over another,
based on a number of factors such as history, reputation,
convenience, scenic beauty, and location.
asbestos A mineral once used in insulation and other
materials that can cause respiratory diseases.
assessment The imposition of a tax, charge, or levy, usually according to established rates.
assets Used alongside liabilities to determine an applicant’s net worth.
assignment The transfer in writing of interest in a bond,
mortgage, lease, or other instrument.
assume A buyer is personally obligated for the payment
of the entire debt of a seller; that is, the buyer assumes the
debt. The original seller is not liable for the debt if the
property is foreclosed on.
air rights The right to use the open space above a property, usually allowing the surface to be used for another
purpose.
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Glossary
attorney’s opinion of title An abstract of title that an
attorney has examined and has certified to be, in the attorney’s opinion, an accurate statement of the facts concerning the property’s ownership.
avulsion The sudden tearing away of land, as by earthquake, flood, volcanic action, or the sudden change in the
course of a stream.
balloon payment A final payment of a mortgage loan
that is considerably larger than the required periodic payments because the loan amount was not fully amortized.
bargain and sale deed A deed that carries with it no warranties against liens or other encumbrances but that does
imply that the grantor has the right to convey title. The
grantor may add warranties to the deed.
base line The main imaginary line running east and west
and crossing a principal meridian at a definite point; used
by surveyors for reference in locating and describing land
under the rectangular (government) survey system of legal
description.
beneficiary (1) The person for whom a trust operates or
in whose behalf the income from a trust estate is drawn.
(2) A lender in a deed of trust loan transaction.
bilateral contract A legally enforceable promise or set of
promises that must be performed and for which, if a breach
of the promise occurs, the law provides a remedy. A contract may be either unilateral, by which only one party is
bound to act, or bilateral, by which all parties to the instrument are legally bound to act as prescribed.
breach of contract Violation of any terms or conditions
in a contract without legal excuse; for example, failure to
make a payment when it is due.
bring down A second title search that is made after the
closing and before any new documents are filed.
Broker-Lawyer Committee The Broker-Lawyer Committee drafts and revises contract forms for use by real
estate licensees, expedites real estate transactions, and
reduces controversies while protecting the interests of the
parties involved.
bundle of legal rights The concept of land ownership
that includes ownership of all legal rights to the land—
possession, control within the law, enjoyment, exclusion,
and disposition.
buydown A financing technique used to reduce the
monthly payments for the first few years of a loan. Funds
in the form of discount points are given to the lender by
the builder or the seller to buy down or lower the effective
interest rate paid by the buyer, thus reducing the monthly
payments for a set time.
buyer agency agreement An employment contract in
which the broker is employed as the buyer’s agent—the
buyer, rather than the seller, is the principal or client.
carbon monoxide (CO) A colorless, odorless gas that
occurs as a by-product of fuel combustion that may result
in death in poorly ventilated areas.
certificate of eligibility Sets forth the maximum guarantee to which the veteran is entitled when applying for
a VA loan.
certificate of reasonable value (CRV) A form indicating the appraised value of a property being financed with
a VA loan.
certificate of title A statement of opinion on the status
of the title to a parcel of real property based on an examination of specified public records.
chain of title The succession of conveyances, from some
accepted starting point, whereby the present holder of real
property derives title.
closing An event where promises made in a sales contract are fulfilled and mortgage loan funds (if any) are distributed to the buyer.
closing agent Completes settlement statements, disburses funds, and files documents to be recorded and sent
to the IRS.
Closing Disclosure A form that itemizes all charges to
be paid by a borrower and a seller in connection with the
settlement and must be delivered to the consumer at least
three days before closing.
cloud on the title Any document, claim, unreleased lien,
or encumbrance that may impair the title to real property
or make the title doubtful; usually revealed by a title search
and removed by either a quitclaim deed or suit to quiet
title.
codicil A supplement or an addition to a will, executed
with the same formalities as a will, which normally does
not revoke the entire will.
commingling The illegal act by a real estate professional
of placing client or customer funds with personal funds.
By law, real estate professionals are required to maintain a
separate trust or escrow account for other parties’ funds held
temporarily by the real estate professional.
common elements Parts of a property that are necessary
or convenient to the existence, maintenance, and safety of
a condominium or are normally in common use by all the
condominium residents. Each condominium owner has an
undivided ownership interest in the common elements.
community property A system of property ownership
based on the theory that each spouse has an equal interest
in the property acquired by the efforts of either spouse during marriage. A holdover of Spanish law found predominantly in the western U.S. states; the system was unknown
under English common law.
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Glossary
computerized loan origination (CLO) An electronic
network for handling loan applications through remote
computer terminals linked to various lenders’ computers.
condemnation A judicial or administrative proceeding
to exercise the power of eminent domain, through which
a government agency takes private property for public use
and compensates the owner.
condominium The absolute ownership of a unit in a
multiunit building based on a legal description of the airspace the unit actually occupies, or a separate dwelling unit
in a multiunit development, plus an undivided interest in
the ownership of the common elements in the building
or development, which are owned jointly with the other
condominium unit owners.
conforming loan A loan that meets the dollar amount
limit set by Fannie Mae and Freddie Mac guidelines.
consent Expressing or implying permission, approval, or
agreement of an action or decision.
consideration (1) That received by the grantor in
exchange for the deed. (2) Something of value that induces
a person to enter into a contract.
construction loan See interim financing.
constructive notice Notice given to the world by
recorded documents. All persons are charged with knowledge of such documents and their contents, whether or not
they have actually examined them. Possession of property
is also considered constructive notice that the person in
possession has an interest in the property.
contingency A provision in a contract that requires a
certain act to be done or a certain event to occur before
the contract becomes binding.
contract A legally enforceable promise or set of promises
that must be performed and for which, if a breach of the
promise occurs, the law provides a remedy. A contract may
be either unilateral, by which only one party is bound to
act, or bilateral, by which all parties to the instrument are
legally bound to act as prescribed.
contract of sale A sales contract that is accepted, signed,
and dated by the seller, and notice of acceptance has been
given to the buyer or the buyer’s agent.
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cooperative A residential multiunit building whose title
is held by a trust or corporation that is owned by and operated for the benefit of people living within the building
who are the beneficial owners of the trust or shareholders
of the corporation, each possessing a proprietary lease to a
property unit.
co-ownership Title ownership held by two or more
persons.
corporation An entity or organization, created by operation of law, whose rights of doing business are essentially
the same as those of an individual. The entity has continuous existence until it is dissolved according to legal
procedures.
cost approach The process of estimating the value of a
property by adding to the estimated land value the appraiser’s estimate of the reproduction or replacement cost of the
building, less depreciation.
counteroffer A new offer made in response to an offer
received. It has the effect of rejecting the original offer,
which cannot be accepted thereafter unless revived by the
offeror.
covenants, conditions, and restrictions (CC&Rs) Private agreements that affect land use. They may be enforced
by an owner of real estate that benefits from them and can
be included in the seller’s deed to the buyer.
credit On a closing statement, an amount entered in a
person’s favor—either an amount the party has paid or an
amount for which the party must be reimbursed.
credit report Documents a person’s creditworthiness and
outlines negative elements affecting that person’s credit
score.
credit score A rating of a borrower’s creditworthiness
based on history of payment, amount owed, length of
credit history, new credit, and other factors.
cross-hatch A mark drawn on an offer, allowing the
buyer and/or seller to initial to accept changes to the offer.
debit On a closing statement, an amount charged; that
is, an amount that the debited party must pay.
controlled business arrangement An arrangement that
offers consumers a package of services (e.g., a real estate
firm, title insurance company, mortgage broker, and home
inspection company).
Deceptive Trade Practices Act (DTPA) A consumer
protection act which protects the public from any false,
misleading, or deceptive act, and from a licensee taking
advantage of the consumer’s lack of knowledge, ability,
experience, or capacity to a grossly unfair degree (i.e., an
unconscionable act).
conventional loan A loan that requires no federally
sponsored insurance or guarantee.
deed A written instrument that, when executed and
delivered, conveys title to or an interest in real estate.
deed in lieu of foreclosure A deed given by the mortgagor to the mortgagee when the mortgagor is in default
under the terms of the mortgage. If accepted by the mortgagee, this is a way for the mortgagor to avoid foreclosure.
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Glossary
deed of trust An instrument used to create a mortgage
lien by which the borrower conveys title to a trustee, who
holds it as security for the benefit of the note holder (the
lender); also called a trust deed.
deed restrictions Clauses in a deed limiting the future
uses of the property. Deed restrictions may impose a vast
variety of limitations and conditions—for example, they
may limit the density of buildings, dictate the types of
structures that can be erected, or prevent buildings from
being used for specific purposes or even from being used
at all.
deficiency judgment Court-ordered ruling that allows
the lender to seek a portion of a borrower’s debt, not satisfied in the foreclosure sale, from the defaulted party’s general assets.
depreciation (1) In appraisal, a loss of value in property
due to any cause, including physical deterioration, functional
obsolescence, and external obsolescence. (2) In real estate
investment, a deduction for tax purposes taken over the
period of ownership of income property, based on the property’s acquisition cost.
devise A transfer of real property by will. The decedent
is the devisor, and the recipient is the devisee.
disclosure Relevant information or facts that are known
or should have been known.
discount point A unit of measurement used for various
loan charges; one point equals 1% of the amount of the
loan.
draws Under a construction loan, payments that the
lender disburses during construction.
earnest money Money deposited by a buyer under the
terms of a contract, to be forfeited if the buyer defaults but
to be applied to the purchase price if the sale is closed.
easement A right to use the land of another for a specific
purpose, such as for a right-of-way or utilities; an incorporeal interest in land because it does not include a right of
possession.
easement appurtenant An easement that follows along
with the land.
easement by necessity An easement allowed by law as
necessary for the full enjoyment of a parcel of real estate
(e.g., a right of ingress and egress over a grantor’s land).
easement by prescription An easement acquired by
open, notorious, continuous, hostile and adverse use of the
property for the period of time prescribed by state law.
easement in gross An easement that is not created for
the benefit of any land owned by the owner of the easement but that attaches personally to the easement owner. For
example, a right granted by a property owner to a friend to
use a portion of the property for the rest of the friend’s life
would be an easement in gross.
eminent domain The right of a government or municipal quasi-public body to acquire property for public use
through a court action called condemnation, in which the
court decides that the use is a public use and determines
the compensation to be paid to the owner. encroachment A building or some portion of it—a wall
or fence, for instance—that extends beyond the land of
the owner and illegally intrudes on the land of an adjoining owner or a public street or alley.
encumbrance Anything—such as a mortgage, tax, or
judgment lien; an easement; a restriction on the use of the
land; or an outstanding dower right—that may diminish
the value or use and enjoyment of a property.
equitable right of redemption Legal process that allows
a defaulted borrower, before a foreclosure sale, to redeem
the property by paying off the entire loan balance, including any interest, costs, and fees.
equitable title Property ownership rights held by the purchaser in conjunction with transferring legal title to the
lender by a security deed. Owner retains a right of redemption to reacquire the legal title from the lender when the
loan is paid off.
erosion The gradual and sometimes imperceptible wearing away of the land by natural forces, such as wind, rain,
and flowing water.
escheat The reversion of property to the state or county,
as provided by state law, in cases in which a decedent dies
intestate without heirs capable of inheriting, or when the
property is abandoned.
escrow closing Occurs when a disinterested third party
is authorized to act as escrow agent (escrow holder) and
to coordinate the closing activities on behalf of the buyer
and the seller.
escrow or impound account Collects property taxes and
insurance.
estate (tenancy) at sufferance The tenancy of a lessee
who lawfully comes into possession of a landlord’s real
estate but who continues to occupy the premises improperly after the lease rights have expired.
estate (tenancy) at will An estate that gives the lessee
the right to possession until the estate is terminated by
either party; the term of this estate is indefinite.
estate for years An interest for a certain, exact period of
time in property leased for a specified consideration.
estate (tenancy) from period to period An interest in
leased property that continues from period to period—
week to week, month to month, or year to year.
estate in land The degree, quantity, nature, and extent
of interest a person has in real property.
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Glossary
227
exchange A transaction in which all or part of the consideration is the transfer of like-kind property (e.g., real
estate for real estate).
fee simple determinable A fee simple estate qualified by
a special limitation. Language used to describe the limitation includes the words so long as, while, or during.
exclusive-agency listing A listing contract under which
the owner appoints a real estate professional as her exclusive agent for a designated period of time to sell the specified property, on the owner’s stated terms, for a commission.
The owner reserves the right to sell the property without
paying anyone a commission if the sale is to a prospect
who has not been introduced or claimed by the real estate
professional.
fee simple subject to a condition subsequent If an estate
is no longer used for the purpose conveyed, it reverts to the
original grantor by the right of reentry.
exclusive-right-to-sell listing An agreement that gives
a brokerage firm the exclusive right to market the seller’s
property and receive a commission during the term of the
listing, regardless of who sells it.
executed contract A contract in which all parties have
fulfilled their promises and thus performed the contract.
executory contract A contract under which something
remains to be done by one or more of the parties.
express contract A contract in which the parties state
the terms and show their intentions in words, either oral
or written.
face-to-face closing The buyer and seller meet together
for closing; may be held at the office of the title company,
the lending institution, an attorney for one of the parties,
the broker, the county recorder, or the escrow company.
Fannie Mae A government-supervised enterprise established to purchase any kind of mortgage loans in the secondary mortgage market from the primary lenders.
Farmer Mac The Federal Agricultural Mortgage Corporation—a privately owned and publicly traded company
established by Congress to create a secondary market for
agricultural mortgage and rural utilities loans and the portions of agricultural and rural development loans guaranteed by the U.S. Department of Agriculture (USDA).
Federal Home Loan Bank (FHLB) A source, for member institutions, of low cost funds when needed for liquidity to meet reserve requirement or have funds to lend.
These borrowings are called “advances” and are secured by
pledged loans already in their portfolio.
Federal Reserve System (Fed) The country’s central
banking system, which establishes the nation’s monetary
policy by regulating the supply of money and interest rates.
fee simple The highest interest in real estate recognized by the law; the holder is entitled to all rights to the
property.
fee simple defeasible An estate in which the holder has
a fee simple title that may be divested upon the occurrence
or nonoccurrence of a specified event.
first mortgage or deed of trust A mortgage that has priority over all other mortgages.
fixture An item of personal property that has been converted to real property by being permanently affixed to the
realty.
flood insurance Required for any property within Federal Emergency Management Agency (FEMA) declared
flood zones.
foreclosure A legal procedure whereby property used as
security for a debt is sold to satisfy the debt in the event
of default in payment of the mortgage note or default of
other terms in the mortgage document. The foreclosure
procedure brings the rights of the parties to a conclusion
and passes the title in the mortgaged property to either the
holder of the mortgage or a third party who may purchase
the realty at the foreclosure sale. Depending on the priority of the foreclosed mortgage, the property may be sold
free of all other encumbrances incurred prior to the sale.
Freddie Mac A government-supervised enterprise established to purchase primarily conventional mortgage loans
in the secondary mortgage market.
freehold estate An estate in land in which ownership is
for an indeterminate length of time, in contrast to a leasehold estate.
future interest A person’s present right to an interest in
real property that will not result in possession or enjoyment until sometime in the future, such as a reversion or
right of reentry.
general partnership See partnership.
general warranty deed A deed in which the grantor fully
warrants good, clear title to the premises. Used in most
real estate deed transfers, a general warranty deed offers
the greatest protection of any deed.
Ginnie Mae A government agency that plays an important role in the secondary mortgage market. It guarantees
mortgage-backed securities using FHA-insured and VAguaranteed loans as collateral.
grantee A person who receives a transfer of real property
from a grantor.
granting clause Words in a deed of conveyance that state
the grantor’s intention to convey the property at the present time. This clause is generally worded as “convey and
warrant”; “grant”; “grant, bargain, and sell”; or the like.
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Glossary
grantor The owner transferring title to or an interest in
real property to a grantee.
in arrears Payments made at the end of a payment
period.
gross lease A lease of property according to which a landlord pays all property charges regularly incurred through
ownership, such as repairs, taxes, insurance, and operating
expenses. Most residential leases are gross leases.
income approach The process of estimating the value of
an income-producing property through capitalization of
the annual net income expected to be produced by the
property during its remaining useful life.
ground lease A lease of land only, on which the tenant
usually owns a building or is required to build as specified
in the lease. Such leases are usually long-term net leases;
the tenant’s rights and obligations continue until the lease
expires or is terminated through default.
index An objective economic indicator to which the
interest rate for an adjustable-rate mortgage is tied.
growing-equity mortgage A loan in which the monthly
payments increase annually, with the increased amount
being used to directly reduce the principal balance outstanding and thus shorten the overall term of the loan.
habendum clause That part of a deed beginning with
the words “to have and to hold,” following the granting
clause and defining the extent of ownership the grantor is
conveying.
heir One who might inherit or succeed to an interest in
land under the state law of descent when the owner dies
without leaving a valid will.
holographic will A will that is written, dated, and signed
in the testator’s handwriting.
home equity line of credit (HELOC) Permits the note
holder to make advances from time to time, secured by the
real estate described in the deed.
home equity loan A loan under which a property owner
uses the property as collateral and can then draw funds up
to a prearranged amount against the property. Also called
a home equity line of credit, or HELOC.
home inspection A thorough visual survey of a property’s structure, systems, and site conditions conducted by a
professional.
homestead Land that is owned and occupied as the family home. In many states, a portion of the area or value of
this land is protected or exempt from judgments for debts
other than those secured by the property.
hypothecation To pledge property as security for an obligation or loan without giving up possession of it.
implied contract A contract in which the agreement of
the parties is demonstrated by their acts and conduct.
impound or escrow account An account that the mortgage lender may require a borrower to have to accumulate funds to pay future real estate taxes and insurance
premiums.
improvement (1) Any structure, usually privately
owned, erected on a site to enhance the value of the property (e.g., a building, fence, or driveway). (2) A publicly
owned structure added to or benefiting land (e.g., a curb,
sidewalk, street, or sewer).
interest A charge made by a lender for the use of money.
interest-only mortgage A loan that only requires the
payment of interest for a stated period of time with the
principal due at the end of the term.
intestate The condition of a property owner who dies
without leaving a valid will. Title to the property will
pass to the decedent’s heirs, as provided in the state law
of descent.
involuntary alienation The act of involuntarily transferring property to another, such as through eminent domain
or adverse possession.
joint tenancy Ownership of real estate between two or
more parties who have been named in one conveyance as
joint tenants. Upon the death of a joint tenant, the decedent’s interest usually passes to the surviving joint tenant
or tenants by the right of survivorship.
kickback Any payment received for a referral when no
service is rendered.
kick-out clause A clause added by a seller to the sales
contract allowing the sellers to market their house while
still involved in a contingent contract based on the prospective buyers selling their house.
land The earth’s surface, extending downward to the center of the earth and upward infinitely into space, including
things permanently attached by nature, such as trees.
land contract A transaction in which the sales price is
paid in two or more installments over two or more years. If
the sale meets certain requirements, a taxpayer can postpone reporting such income until future years by paying
tax each year only on the proceeds received that year. Also
called an installment sale.
lease A written or oral contract between a landlord (the
lessor) and a tenant (the lessee) that transfers the right to
exclusive possession and use of the landlord’s real property
to the lessee for a specified period of time and for a stated
consideration (rent). By state law, leases for longer than a
certain period of time (generally one year) must be in writing to be enforceable.
lease purchase The purchase of real property, the consummation of which is preceded by a lease, usually long
term, that is typically done for tax or financing purposes.
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229
leasehold estate A tenant’s right to occupy real estate
during the term of a lease, generally considered a personal
property interest, although a long-term lease may be eligible for treatment as real property for financing purposes.
Loan Estimate An estimate of all closing fees that must
be provided to a borrower within three days of the loan
application as required by the Real Estate Settlement Procedures Act (RESPA).
legal description A description of a specific parcel of real
estate complete enough for an independent surveyor to
locate and identify it.
loan origination fee A fee charged to the borrower by
the lender for making a mortgage loan. The fee is usually
computed as a percentage of the loan amount.
legally competent All parties must be of legal age and
have enough mental capacity to understand the nature or
consequences of their actions in the contract.
loan-to-value (LTV) ratio The relationship between
the amount of the mortgage loan and the value of the real
estate being pledged as collateral.
lessee See lease.
lot-and-block (recorded plat) method A method of
describing real property that identifies a parcel of land by
reference to lot and block numbers within a subdivision, as
specified on a recorded subdivision plat.
lessor See lease.
letter of intent (LOI) Used to outline the basic terms
that a buyer may agree to prior to a complex sales agreement. Non-binding language is usually inserted so as to
not create a contract. Used primarily in commercial
transactions.
liabilities Used alongside assets to determine an applicant’s net worth.
license (1) In real estate practice, the privilege or right
granted to a person by a state to operate as a real estate broker or salesperson. (2) The revocable permission for a temporary use of land—a personal right that cannot be sold.
lien A right given by law to certain creditors to have
their debts paid out of the property of a defaulting debtor,
usually by means of a court sale.
lien theory Principle in which the mortgagor retains
both legal and equitable title to property that serves as
security for a debt. The mortgagee has a lien on the property, but the mortgage is nothing more than collateral for
the loan.
life estate An interest in real or personal property that
is limited in duration to the lifetime of its owner or some
other designated person or persons.
limited liability company (LLC) A form of business
organization that combines the most attractive features of
limited partnerships and corporations.
limited partnership See partnership.
liquidated damages An amount predetermined by the
parties to a contract as the total compensation to an
injured party should the other party breach the contract.
lis pendens A recorded legal document giving constructive notice that an action affecting a particular property
has been filed in either a state or a federal court.
littoral rights (1) A landowner’s claim to use water in
large navigable lakes and oceans adjacent to her property.
(2) The ownership rights to land bordering these bodies of
water up to the high-water mark.
manufactured housing Dwellings that are built off site
and trucked to a building lot where they are installed or
assembled.
margin A premium added to the index rate representing
the lender’s cost of doing business.
market value The most probable price that a property
would bring in an arm’s-length transaction under normal
conditions on the open market.
marketable title Good or clear title, reasonably free from
the risk of litigation over possible defects.
mechanic’s lien A statutory lien created in favor of contractors, laborers, material suppliers, and others who have
performed work or furnished materials in the erection or
repair of a building.
metes and bounds Controlling real property legal
description in Georgia that surveys a property’s boundaries to form a geometrically enclosed outline of the parcel,
always ending up at its starting point.
mold A form of fungus that can be found almost anywhere and can grow on almost any organic substance, so
long as moisture and oxygen are present. Mold growth can
gradually destroy what it is growing on, as well as cause
serious health problems.
month-to-month tenancy A periodic tenancy under
which the tenant rents for one month at a time. In the
absence of a rental agreement (oral or written), a tenancy
is generally considered to be month to month.
monument A fixed natural or artificial object used to
establish real estate boundaries for a metes-and-bounds
description.
mortgage A conditional transfer or pledge of real estate
as security for the payment of a debt. Also, the document
creating a mortgage lien.
mortgage insurance premium (MIP) An insurance
policy premium used in FHA loans that the borrower is
charged. The premium depends on the length of the loan
and the loan-to-value (LTV) ratio.
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Glossary
mortgage lien A lien or charge on the property of a
mortgagor that secures the underlying debt obligation.
option An agreement to keep open for a set period an
offer to sell or purchase property.
multiple listing service (MLS) A marketing organization composed of member real estate professionals who
agree to share their listing agreements with one another
in the hope of procuring ready, willing, and able buyers
for their properties more quickly than they could on their
own. Most multiple listing services accept exclusive rightto-sell or exclusive agency listings from their member real
estate professionals.
ownership and use tests Tests that determine whether
capital gain from the sale of a home may be excluded.
negotiable instrument A written promise or order to
pay a specific sum of money that may be transferred by
endorsement or delivery. The transferee then has the original payee’s right to payment.
net lease A lease requiring the tenant to pay not only
rent but also costs incurred in maintaining the property,
including taxes, insurance, utilities, and repairs.
net listing A listing based on the net price the seller will
receive if the property is sold. Under a net listing, the real
estate professional can offer the property for sale at the
highest price obtainable to increase the commission. This
type of listing is illegal in many states.
net worth Calculated by determining the borrower’s
assets and liabilities.
nonconforming loan A loan that exceeds the Federal
Housing Finance Agency (FHFA) loan limits; also called
a jumbo loan.
nonhomogeneity A lack of uniformity; dissimilarity.
Because no two parcels of land are exactly alike, real estate
is said to be nonhomogeneous.
novation Substituting a new obligation for an old one or
substituting new parties to an existing obligation.
nuncupative will An oral will declared by the testator
in his final illness, made before witnesses and afterward
reduced to writing; not permitted by all states.
offer A promise made by one party, requesting something in exchange for that promise.
offer to purchase A sales contract that has been prepared, signed, and dated by a buyer.
offeree The person to whom the offer is made.
offeror The person who makes the offer.
oil and gas lease An agreement by which a landowner
allows for the exploration and production of oil and gas on
the landowner’s property in return for payment.
open listing A listing contract under which the real
estate professional’s compensation is contingent on the
real estate professional producing a ready, willing, and able
buyer before the property is sold by the seller or another
real estate professional.
package loan A real estate loan used to finance the purchase of both real property and personal property, such as
in the purchase of a new home that includes carpeting,
window coverings, and major appliances.
partition The division of cotenants’ interests in real
property when the parties do not all voluntarily agree to
terminate the co-ownership; takes place through a court
procedure.
partnership An association of two or more individuals
who carry on a continuing business for profit as co-owners. Under the law, a partnership is regarded as a group of
individuals rather than as a single entity separate from the
individual owners. A general partnership is a typical form
of joint venture in which each general partner shares in
the administration, profits, and losses of the operation. A
limited partnership is a business arrangement whereby the
operation is administered by one or more general partners
and funded, by and large, by limited or silent partners, who
are by law responsible for losses only to the extent of their
investments.
payment cap The limit on the amount the monthly
payment can be increased on an adjustable-rate mortgage
when the interest rate is adjusted.
percentage lease A lease, commonly used for commercial property, whose rental is based on the tenant’s gross
sales at the premises; it usually stipulates a base monthly
rental plus a percentage of any gross sales above a certain
amount.
personal property Items, called chattels, that do not fit
into the definition of real property; movable objects.
plat map A map of a town, section, or subdivision indicating the location and boundaries of individual properties.
point of beginning (POB) In a metes-and-bounds legal
description, the starting point of the survey, situated in
one corner of the parcel; all metes-and-bounds descriptions must follow the boundaries of the parcel back to the
point of beginning.
police power The government’s right to impose laws,
statutes, and ordinances, including zoning ordinances and
building codes, to protect the public health, safety, and
welfare.
power of attorney Legal document that gives individuals the right to sign legal documents for another. In Georgia, document must be executed with the same formality
required for a deed.
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Glossary
preapproval letter The lender has taken information
from the borrower and determined that, if everything the
borrower said is true, then the borrower is likely to get the
loan.
prepayment penalty A charge imposed on a borrower
who pays off the loan principal early. This penalty compensates the lender for interest and other charges that
would otherwise be lost.
primary mortgage market The mortgage market in
which loans are originated, consisting of lenders such as
commercial banks, savings associations, and mutual savings banks.
principal meridian The main imaginary line running
north and south and crossing a base line at a definite point;
used by surveyors for reference in locating and describing
land under the rectangular (government) survey system of
legal description.
prior appropriation A concept of water ownership in
which the landowner’s right to use available water is based
on a government-administered permit system.
priority The order of position or time. The priority of
liens is generally determined by the chronological order in
which the lien documents are recorded; tax liens, however,
have priority even over previously recorded liens.
private mortgage insurance (PMI) Insurance provided
by a private carrier that protects a lender against a loss in
the event of a foreclosure and deficiency.
probate A legal process by which a court determines who
will inherit a decedent’s property and what the estate’s
assets are.
promissory note A financing instrument that states the
terms of the underlying obligation, is signed by its maker,
and is negotiable (transferable to a third party).
promulgate To publish and make available for use.
proprietary lease A lease given by the corporation that
owns a cooperative apartment building to a shareholder
who has the right as a tenant to an individual unit.
prorations Expenses, either prepaid or paid in arrears,
that are divided or distributed between the buyer and the
seller at the closing.
pur autre vie “For the life of another.” A life estate pur
autre vie is a life estate that is measured by the life of a
person or persons other than the grantee.
purchase money mortgage (PMM) A note secured by a
mortgage or deed of trust given by a buyer, as borrower, to
a seller, as lender, as part of the purchase price of the real
estate.
quitclaim deed A conveyance that transfers whatever
interest the grantor has in the specified real estate, without
warranties or obligations.
231
radon A naturally occurring gas that is suspected of causing lung cancer.
range A strip of land six miles wide, extending north
and south and numbered east and west according to its distance from the principal meridian in the rectangular (government) survey system of legal description.
rate cap The limit on the amount the interest rate can
be increased at each adjustment period in an adjustable
rate loan. The cap may also set the maximum interest rate
that can be charged during the life of the loan.
real estate Land; a portion of the earth’s surface extending downward to the center of the earth and upward
infinitely into space, including all things permanently
attached to it, whether naturally or artificially.
Real Estate Settlement Procedures Act (RESPA) The
federal law that requires certain disclosures to consumers
about mortgage loan settlements. The law also prohibits
the payment or receipt of kickbacks and certain kinds of
referral fees.
real property The interests, benefits, and rights inherent
in real estate ownership; often used as a synonym for real
estate.
reconveyance deed A deed used by a trustee under a
deed of trust to return title to the trustor.
recording The act of entering or recording documents
affecting or conveying interests in real estate in the recorder’s office established in each county. Until it is recorded, a
deed or a mortgage ordinarily is not effective against subsequent purchasers or mortgagees.
rectangular survey system A system established in 1785
by the federal government, providing for surveying and
describing land by reference to principal meridians and
base lines.
Regulation Z Implements the Truth in Lending Act,
requiring credit institutions to inform borrowers of the
true cost of obtaining credit.
release deed A document, also known as a deed of reconveyance, that transfers all rights given a trustee under a
deed of trust loan back to the grantor after the loan has
been fully repaid.
remainder interest The remnant of an estate that has
been conveyed to take effect and be enjoyed after the termination of a prior estate, such as when an owner conveys
a life estate to one party and the remainder to another.
rescission The practice of one party canceling or terminating a contract, which has the effect of returning the
parties to their original positions before the contract was
made.
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Glossary
reverse mortgage A loan by which a homeowner
receives a lump sum, monthly payments, or a line of credit
based on the homeowner’s equity in the property secured
by the mortgage. The loan must be repaid at a prearranged
date, upon the death of the owner, or upon the sale of the
property.
reversionary interest The remnant of an estate that the
grantor holds after granting a life estate to another person.
reversionary right The return of the rights of possession
and quiet enjoyment to the lessor at the expiration of a
lease.
revocation Canceling or annulling licensed privileges or
rights.
right of first refusal A clause allowing the tenant the
opportunity to buy the property before the owner accepts
an offer from another party.
severalty Ownership of real property by one person only;
also called sole ownership.
severance Changing an item of real estate to personal
property by detaching it from the land (e.g., cutting down
a tree).
short sale Sale of property in which the sales price is less
than the remaining indebtedness.
situs The location of land for legal purposes; the jurisdiction in which land is located.
special warranty deed A deed in which the grantor warrants, or guarantees, the title only against defects arising
during the period of the grantor’s tenure and ownership of
the property and not against defects existing before that
time, generally using the language, “by, through, or under
the grantor but not otherwise.”
right of survivorship The right, upon the death of a
joint tenant, that the decedent’s interest passes to the surviving joint tenant or tenants.
statute of frauds That part of a state law that requires
certain instruments, such as deeds, real estate sales contracts, and certain leases, to be in writing to be legally
enforceable.
riparian rights An owner’s rights in land that borders on
or includes a stream, river, or lake. These rights include
access to and use of the water.
straight loan A loan in which only interest is paid during the term of the loan, with the entire principal amount
due with the final interest payment.
sales comparison approach The process of estimating
the value of a property by examining and comparing sales
and listings of comparable properties.
subdivision plat A map of a subdivision indicating the
location and boundaries of individual properties.
satisfaction Release or discharge when a note has been
fully paid, returning to the borrower all interest in the
real estate originally conveyed to the lender. Entering this
release in the public record shows that the debt has been
removed from the property.
school section Section 16 of a township square.
second mortgage or deed of trust A lien junior to the
first mortgage or deed of trust.
secondary mortgage market A market for the purchase
and sale of existing mortgages, designed to provide greater
liquidity for mortgages. Mortgages are first originated in
the primary mortgage market.
section A portion of a township under the rectangular
(government) survey system. A township is divided into
36 sections, numbered 1 through 36. A section is a square
with mile-long sides and an area of one square mile, or 640
acres.
security deposit A payment by a tenant, held by the
landlord during the lease term, and kept (wholly or partially) on default or on destruction of the premises by the
tenant.
separate property Under community property law, property owned solely by either spouse before the marriage,
acquired by gift or inheritance during the marriage, or purchased with separate funds after the marriage.
subject to Buyer takes title of property and makes payments on the existing loan but is not personally obligated
to pay the debt in full. Original seller might continue to be
liable for debt.
sublease The leasing of premises by a lessee to a third
party for part of the lessee’s remaining term. See also
assignment.
subsurface rights Ownership rights in a parcel of real
estate to the water, minerals, gas, oil, and so forth that lie
beneath the surface of the property.
suit for specific performance If the seller breaches a real
estate sales contract, the buyer may sue, asking the court
to force the seller to go through with the sale and convey
the property as previously agreed.
suit to quiet title A court action intended to establish
or settle the title to a particular property, especially when
there is a cloud on the title.
surface rights Ownership rights in a parcel of real estate
that are limited to the surface of the property and do not
include the space above it (air rights) or the substances
below the surface (subsurface rights).
survey The process by which boundaries are measured
and land areas are determined; the on-site measurement
of lot lines, dimensions, and position of a house on a lot,
including the determination of any existing encroachments or easements.
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Glossary
synthetic stucco Exterior insulation finish systems
(EIFS), which do not allow moisture to escape, possibly
leading to moisture problems and mold.
tacking Concept providing that successive periods of
continuous occupation by different parties may be combined to reach the required total number of years needed
to establish a claim for a prescriptive easement.
taxation The process by which a government body raises
monies to fund its operation.
tenancy in common (TIC) A form of co-ownership
by which each owner holds an undivided interest in real
property as if each were sole owner. Each individual owner
has the right to partition. Unlike joint tenants, tenants in
common have the right of inheritance.
testate Having made and left a valid will.
testator A person who has made a valid will. A woman
might be referred to as a testatrix, although testator can be
used for either a man or a woman.
Texas Real Estate Commission (TREC) Texas regulatory agency created to administer the Texas Real Estate
License Act. It has rule-making authority, and its rules
have the full force and effect of law.
Texas Real Estate License Act (TRELA) Protects the
public through regulation of licensed real estate brokerage practitioners, real estate inspectors, residential service
companies, and entities offering timeshare interests.
thrifts A generic term for a savings association.
“time is of the essence” A phrase in a contract that
requires the performance of a certain act within a stated
period of time.
time-share A form of ownership interest that may
include an estate interest in property and that allows use
of the property for a fixed or variable time period.
time-share estate A time-share tied to a particular unit
for a particular space of time. If a fee estate, the purchaser
receives a deed.
time-share use The right to occupy and use the facilities for a certain number of years, after which the owner’s
rights in the property terminate.
title (1) The right to ownership or the ownership of
land. (2) The evidence of ownership of land.
title insurance A policy insuring a property owner or
mortgagee against loss by reason of defects in the title to
a parcel of real estate, other than encumbrances, defects,
and matters specifically excluded by the policy.
title search The examination of public records relating to real estate to determine the current state of the
ownership.
233
tort An act that damages another individual and gives
rise to legal action.
township The principal unit of the rectangular (government) survey system. A township is a 6-mile square of 36
square miles.
township line All the lines in a rectangular survey system that run east and west, parallel to the base line and six
miles apart.
township tier Township lines that form strips of land
and are designated by consecutive numbers north or south
of the base line.
trade fixture An article installed by a tenant under the
terms of a lease that is removable by the tenant before the
lease expires.
transfer tax An excise tax on the sale of real property in
Georgia. Levied at the rate of 0.10 for every $100 of net
sales price (sales price less any assumable loan).
trigger terms Specific credit terms, such as down payment, monthly payment, and amount of finance charge or
term of loan.
tri-merge credit report A credit report that contains
credit information and credit scores from all three major
credit reporting agencies.
trust A fiduciary arrangement whereby property is conveyed to a person or an institution, called a trustee, to be
held and administered on behalf of another person, called
a beneficiary. The one who conveys the trust is called the
trustor.
trustee One to whom something is entrusted and who
holds legal title to property and administers the property
for the benefit of a beneficiary. Can also be a member of a
board entrusted with the administration of an institution
or organization, such as a cooperative.
trustee’s deed A deed executed by a trustee conveying
land held in a trust.
trustor A borrower in a deed of trust loan transaction;
one who places property in a trust. Also called a grantor
or settler.
Truth in Lending Act (TILA) Federal government regulates the lending practices of mortgage lenders through
this act.
underground storage tanks (USTs) Commonly found
on sites where petroleum products are used or where gas
stations and auto repair shops are located, and subject to
federal and state regulations. In residential areas, tanks are
used to store heating oil. Over time, neglected tanks may
leak hazardous substances into the environment.
underwriter Approves, rejects, or returns the loan package to processing with contingency requirements that must
be met before resubmission for approval.
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234
Glossary
unenforceable contract A contract that has all the elements of a valid contract, yet neither party can sue the
other to force performance of it. For example, an unsigned
contract is generally unenforceable.
unilateral contract A one-sided contract wherein one
party makes a promise so as to induce a second party to
do something. The second party is not legally bound to
perform; however, if the second party does comply, the first
party is obligated to keep the promise.
usury Charging interest at a higher rate than the maximum rate established by state law.
valid contract A contract that complies with all the
essentials of a contract and is binding and enforceable on
all parties to it.
void contract A contract that has no legal force or
effect because it does not meet the essential elements of
a contract.
voidable contract A contract that seems to be valid on
the surface but may be rejected or disaffirmed by one or
both of the parties.
voluntary alienation The act of voluntarily transferring
property to another, such as by gift or sale.
walk-through A final inspection in which the buyer
verifies that all necessary repairs have been made, that the
property has been well maintained, and that all systems
and fixtures are in substantially the same condition that
they were in at the time the contract was finalized.
walk-through items Items that must be brought into
normal working condition before settlement.
water rights Common law rights held by owners of land
adjacent to rivers, lakes, or oceans; includes restrictions on
those rights and land ownership.
will A written document, properly witnessed, providing
for the transfer of title to property owned by the deceased,
called the testator.
zero tolerance Items on final Loan Estimate that may
not differ from the original.
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Answer Key for Unit Review Questions
Unit 1 Review Questions
1. c The answer is protect the public. The TREC
administers the act.
2. d The answer is all of these. The DTPA protects the public from false, misleading, deceptive,
and unconscionable acts.
3. c The answer is licensee advises both the seller
and the buyer that, in his opinion, title to the
subject property is encumbered. Licensees cannot advise a person regarding the validity or legal
sufficiency of an instrument or the validity of
title to real property.
4. c The answer is the buyer’s attorney has drafted
a contract that the buyer insists on using. In
addition, licensees don’t have to use the promulgated forms when acting as a principal, when an
agency of the United States government requires
a different form, or when no standard contract
form promulgated by the TREC exists.
5. d The answer is use a form prepared by the
Broker-Lawyer Committee and made available
for trial use by licensees with the consent of
TREC. The licensee could also use a form prepared by an attorney.
6. a The answer is treble damages and a mental
anguish award. The DTPA offers treble damages
and a mental anguish award.
7. a The answer is one spouse to another in a
divorce proceeding. One spouse does not need to
provide a seller’s disclosure to the other spouse in
a divorce proceeding.
8. a The answer is most sellers of residential property to provide the buyer with a written notice of
the property’s condition. There are exceptions to
the disclosure requirement. TREC Form OP-H
includes the language required by the Texas
Property Code, but the form itself is not required
by the property code.
9. c The answer is a contract for the sale of a fiveunit residential building. TREC does not supply a promulgated form for the sale of five-unit
residential buildings.
10. b The answer is buyer may terminate the
contract within seven days after receipt of the
disclosure. If a contract is entered without the
seller providing the notice required by this section, the purchaser may terminate the contract
for any reason within seven days after receiving
the notice.
Unit 2 Review Questions
1. c The answer is annual crops. Annual crops,
also known as emblements, are considered personal property.
2. d The answer is disposition. The right of disposition allows property to be sold, willed, transferred, or otherwise disposed of.
3. a The answer is the cost of the item when
it was purchased. The cost of the item has no
bearing on the decision of whether it is real or
personal property.
4. c The answer is subsurface rights. The mineral
rights would be subsurface rights because the
minerals are located in land below the surface.
5. b The answer is personal property. The lumber
is still personal property when it is delivered; it
becomes real property after it has been built into
the structure.
6. b The answer is condominium. In a condominium, the owner has a fee simple interest in
the unit, along with a percentage interest in the
common elements.
7. d The answer is community property. Community property considers a married couple as equal
partners rather than as one entity; all property
acquired during the marriage is equally divided
unless received by gift or inheritance.
8. d The answer is cooperative. In a cooperative,
the owner has a proprietary right to occupy a
unit and own shares in the corporation.
9. d The answer is a tenancy by the entirety. In
states that allow for tenancy by the entirety, the
couple is considered to be one unit and have
rights of survivorship if one party dies.
10. b The answer is ownership in severalty.
Although the word seems somewhat contradictory, in severalty means a single owner (severed
from others).
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Answer Key
Unit 3 Review Questions
Unit 4 Review Questions
1. a The answer is a sale of a 10-unit apartment
1. a The answer is fee simple interest. A fee
building. TREC does not promulgate a form for
simple interest provides an owner with total
the sale of 10-unit apartment buildings.
ownership and control over a property with the
exception of certain governmental powers.
2. d The answer is all parties to the contract
2. c The answer is fee simple determinable. A fee
exchange binding promises. Bilateral means that
simple determinable has a special limitation on
each of the parties agrees to give something (i.e.,
what can, or cannot, be done with the property.
buyer and seller, seller and listing broker, landIf the limitation is violated, the property may
lord and tenant).
3. a The answer is a duplex. A property disclosure
revert back to the original owner.
3. a The answer is dedication. Governmental
agreement is not needed for a duplex.
4. b The answer is an executory contract. A
powers are those of police power, escheat, emicontract for deed for a period of two years is an
nent domain, and taxation.
4. c The answer is homestead. Homestead is a
executory contract.
5. c The answer is in writing to be enforceable.
legal life estate that protects some amount of real
A contract for sale must include the elements
and personal property from creditors; the homeof offer and acceptance, consideration, legally
stead is not protected from real estate taxes or a
competent parties, and consent and legal purmortgage.
5. b The answer is remainder. When an owner
pose, and it must be in writing to be enforceable.
conveys property but retains a life estate, the
If any element is missing, the contract is void.
6. b The answer is option. An option is a uniparty to whom the property will go upon the
lateral contract (only a promise by one party)
death of the owner has a remainder interest.
6. c The answer is homestead rights. Protection
that gives a potential buyer an opportunity to
from creditors is called homestead rights and varpurchase a property at a given amount within a
ies from state to state.
stated time-frame. In most cases, a fee is paid for
7. a The answer is an easement in gross. An easethe option.
7. a The answer is no commission. An exclusivement in gross gives an individual or a company
agency listing authorizes one broker to represent
the rights to an easement across a number of
the principal; however, the seller retains the
properties; a commercial easement in gross may
right to sell the property without paying a combe assigned, conveyed, or inherited. A personal
mission to the broker.
easement in gross usually terminates on the
8. b The answer is a definite contract terminadeath of the easement owner.
8. a The answer is easement by necessity. An
tion date. There are many clauses that may be
easement by necessity is not for convenience; it
included in a listing agreement, but the one
provides ingress and egress from land which must
that is required by most states is a definite date
not be landlocked.
for termination of the contract. In fact, in some
9. a The answer is fee simple absolute. A fee
states, the lack of a definite termination date
simple absolute interest is the highest interest a
could cause a suspension or revocation of the
person may have in real estate.
broker’s license.
9. c The answer is do nothing, because the agree10. c The answer is a commercial property purment will terminate automatically at the end of
chase. A Phase I assessment is generally associthe current term. A tenancy for years has specific
ated with a commercial real estate purchase.
starting and ending dates. No notice is required
Unit 5 Review Questions
because the agreement is automatically terminated on the ending date specified in the lease.
1. d The answer is have both parties initial or sign
10. d The answer is tenancy at sufferance. A tenin the margin near each change. Any change in
ancy by sufferance is created when a tenant who
the contract first requires the initials of the party
lawfully occupied the property continues to stay
making the change. The contract is not actually
on after the expiration date of the lease without
ratified until the other party has also initialed
the permission of the landlord. If the lease does
the change. The cross-hatch with initials could
not have a “holdover” clause that governs the
be dated to ensure no future controversy.
rights of both landlord and tenant, state law will
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Answer Key
2. d The answer is conversion of funds and is
illegal. State license law has strict regulations
about the disposition of earnest money funds;
they absolutely cannot be used by the broker for
any business or personal purpose.
3. c The answer is a history of previous owners of
the property. The title company will research the
chain of title to be sure there are no other claims
on the property, but this is not a detail included
in a sales contract.
4. b The answer is buyer is notified that the seller
has accepted the offer. In today’s electronic
world, there may be a question as to when an
offer was accepted or rejected or a counteroffer
was made and accepted. A standard contract
may state that electronic transmissions are valid.
5. b The answer is put the deposit in an account,
as provided by state law. Even though some, or
all, of the earnest money deposit may eventually become the property of the broker, it must
initially be placed in a special account as specified by state law.
6. b The answer is metes and bounds. Metes and
bounds is the oldest of the methods used for legal
description. It describes a property using linear
measurements, natural and specific landmarks,
and directions from a point of beginning (POB)
around to a return to the POB.
7. b The answer is 16. Historically, the school was
usually located in Section 16 of the rectangular
(government) survey system. Section 16 is still
called the “school section” although the actual
school may be elsewhere.
8. c The answer is street address. The street
address is adequate for some business transactions
but never as a legal description. Municipalities
often change street names or numbering systems
as communities grow.
9. b The answer is place a lis pendens. A lis pendens (lien pending) is merely serving legal notice
that a suit may be coming. The three remedies
available to a seller if a buyer defaults are rescission of the contract, a suit for specific performance, or a suit for damages.
10. d The answer is the Uniform Vendor and
Purchaser Risk Act. In many states, the buyer
assumes the risk of any damage to the property
during the time between contract and closing;
other states have determined that the risk should
remain with the seller and have incorporated
portions of the Uniform Vendor and Purchaser
Risk to protect the buyer.
237
Unit 6 Review Questions
1. d The answer is leaving the termination date
of the contingency open until the projected
closing date. If the sale of home contingency is
allowed to continue up to the date of settlement,
the seller has no protection. On the projected
settlement date, the contract could become void.
At the least, the seller should retain the right to
continue marketing the property with a kick-out
clause to the buyer.
2. b The answer is seller. A disclosure of leadbased paint hazard is required for all properties
built before 1978. Because lead-based paint has
proven to be hazardous to children, a family with
young children may want to have the property
inspected.
3. c The answer is voidable. Any contingency
must be satisfactorily accomplished before a contract can proceed to closing. If the contingency
is not resolved, the contract becomes void; in
the meantime, it is voidable.
4. b The answer is appraisal contingency. An
appraisal indicating a value that is less than the
agreed-upon sales price might make it impossible for the buyer to obtain the financing as
described, due to the lender’s loan-to-value ratio.
One solution is for the seller to reduce the sales
price to an amount that will allow the financing
needed.
5. c The answer is is knowledgeable about most
home systems and construction but is not an
expert. A home inspector has general knowledge
about the various systems in a house: plumbing,
electric, heating, and cooling, along with major
appliances. The inspector may also point out
problems with drainage, termite destruction, or
roof damage. The inspector is not an expert in
any one field and will recommend a specialist if
it seems necessary.
6. a The answer is is a change to existing content
in the contract. The use of an amendment form
and an addendum form are often confused. An
amendment is a change to what it is in the original contract; an addendum is new material being
added to the contract. In either case, the other
party must sign off on the change or addition for
the contract to remain in full force.
7. a The answer is home inspection and termite.
Home and pest inspections are the two most
common types of inspections for homebuyers.
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238
Answer Key
8. c The answer is when the final selling price
will be less than the loan amount. A short sale
may be an option if the property’s final selling
price will be less than is the amount owed on the
loan (i.e., the loan is “underwater”).
9. d The answer is it gives time to negotiate
repairs. The period between the inspection and
the end of the option period should be used to
negotiate any necessary repairs identified by the
inspection.
10. b The answer is loan contingency. While all of
these contingencies are intended to protect the
buyer, the loan contingency is used most often.
Unit 7 Review Questions
1. a The answer is mortgagor. The term mortgagor is often confused with mortgagee. The
mortgagor is the borrower (similar ending). The
lender is the mortgagee.
2. d The answer is acceleration. The acceleration
clause in a mortgage contract makes the entire
loan amount due when a borrower defaults.
Without an acceleration clause, the lender would
have to sue each time a payment was missed.
3. c The answer is credit union. A credit union
makes mortgage loans to its members and is part
of the primary mortgage market. Fannie Mae
and Freddie Mac purchase packages of loans on
the secondary market, and Ginnie Mae guarantees mortgage-backed securities created in the
secondary market.
4. b The answer is life insurance company. The
primary market lenders for single-family residences are generally commercial or mutual savings banks, savings associations, or credit unions.
Life insurance companies and pension funds
usually invest in larger projects.
5. b The answer is buy and pool blocks of conventional mortgages. Freddie Mac was originally
created to purchase conventional loans and
package them for sale as securities on the secondary market. Today Freddie Mac occasionally
purchases government loans as well.
6. a The answer is the amount of interest to
be paid is predetermined. The rate of interest
charged on a fixed-rate loan does not change.
The actual monthly payment may change
slightly on an annual basis due to fluctuations in
the real estate taxes and homeowner insurance
premiums.
7. c The answer is approved lenders. Although
it is called an FHA loan, the funds are actually received from an FHA-approved lender.
FHA insures the loan in case of default by the
borrower.
8. b The answer is each principal and interest
mortgage payment amount is the same. With
a fully amortized loan, each monthly payment
is the same, but in the beginning, the portion
allowed for interest is larger than that allowed
toward the principal. Over the years, the principal amount increases and the amount of interest
decreases.
9. d The answer is amount of income. The Equal
Credit Opportunity Act does not allow a lender
to discriminate on the basis of race, color, religion, national origin, sex, age, marital status, or
source of income. Insufficient amount of income
would cause a loan to be denied.
10. d The answer is Truth in Lending Act (Regulation Z). The Truth in Lending Act requires
disclosure of all costs of credit to a consumer.
Regulation Z of that act specifies that if any one
of the terms of financing are advertised, all of the
terms must be disclosed, including the annual
percentage rate (APR).
Unit 8 Review Questions
1. b The answer is general warranty. A general
warranty deed provides the covenants of seisin,
against encumbrances, quiet enjoyment, further
assurance, and warranty forever. The grantor
even defends the title on behalf of everyone who
has held title in the past. (In most cases, a purchaser will still choose to have further protection
by purchasing a title insurance policy.)
2. d The answer is ensures that the title will be
good against the title claims of third parties. The
covenant of quiet enjoyment has nothing to do
with noisy neighbors; the seller is ensuring that
there will be no future claims against the title to
the property.
3. b The answer is bargain and sale. A bargain
and sale deed contains no express warranties,
but it does imply that the grantor holds title to
the property. The purchaser has limited legal
recourse if defects in the title come up later.
4. d The answer is involuntary alienation.
Eminent domain and escheat are both cases of
involuntary alienation of property. The owner
does not choose to have the state take over the
property either for public use (eminent domain)
or when there are no heirs (escheat).
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Answer Key
5. c The answer is intestate. An individual who
dies “testate” has a will indicating how property
is to be distributed; to die “intestate” means to
die without a will, which passes real and personal
property to the decedent’s heirs according to
state law.
6. c The answer is in both the county where the
decedent resided and the county in which the
property is located. The purpose of probate is
to determine that a will is processed correctly.
Probate proceedings take place in the county or
city where the decedent resided and also in the
county or city where real property is located.
Probate procedures are governed by state law.
7. d The answer is a record of a property’s ownership. The chain of title is the record of ownership going back at least 60 years in the public
records. Any gap in the chain of title will be
addressed as a “cloud on the title.”
8. a The answer is C has been given constructive notice of the prior sale because B promptly
recorded the deed. Properly recorded documents
provide constructive notice to the world of one
person’s rights to a property. Purchaser C should
have made a title search prior to purchasing A’s
property.
9. b The answer is improperly delivered deeds. In
addition to what is found in the public records,
a standard title insurance policy insures against
forged documents, conveyances by incompetent grantors, incorrect marital statements, and
improperly delivered deeds.
10. c The answer is the amount of coverage is
commensurate with the loan amount. A lender
requires a borrower to obtain a title insurance
policy in an amount that will cover the amount
of the mortgage loan. If the purchaser wants
additional coverage, an owner’s policy may be
added.
Unit 9 Review Questions
1. d The answer is the seller usually pays the
expenses for the day of closing. In the majority
of states, the seller is responsible for all expenses,
including the day of closing; in others, the buyer
becomes responsible on the day of closing.
2. b The answer is arranging for homeowners
insurance. The closing agent has many responsibilities leading up to the day of closing, but
obtaining homeowners insurance is the responsibility of the purchaser. Most likely, this will need
to be done fairly early in the transaction as part
of information submitted to the lender.
239
3. b The answer is seller. The seller must be able
to show proof that any existing loan or other
liens have been paid in full. The closing agent
obtains a pay-off figure from the existing lender
and may bring an existing lien to the seller’s
attention, but the seller is ultimately responsible.
4. a The answer is cost approach. Capitalization
will not work because there is no rent paid, and
market data will not work because there is insufficient data and the variances are too great to
correlate.
5. c The answer is credit score. The borrower’s
credit score is not needed to complete the Uniform Residential Loan Application.
6. d The answer is they may avoid capital gains
tax up to $450,000. The sellers must have occupied the home as a principal home for two of the
last five years to avoid capital gains tax.
7. c The answer is a lending institution. When
a buyer assumes the seller’s existing mortgage
loan, the lender is usually required to furnish a
mortgage reduction certificate that certifies the
amount due on the loan, the interest rate, and
the date and amount of the last payment.
8. b The answer is the addition of a prepayment
penalty. The other two instances that would
require a new Closing Disclosure and a three-day
waiting period before the loan can close are the
following: 1) increasing the annual percentage
rate (APR) by more than one-eighth of a percentage point for a fixed-rate loan or one-fourth
of a percentage point for an adjustable-rate loan
(decreasing the interest rate or fees doesn’t cause
a delay) and 2) changes in the loan product
(from a fixed-rate to an adjustable-rate loan, for
example).
9. c The answer is schedule repairs needed as
result of home inspection. The buyer makes the
requests for repairs for defects discovered in a
home inspection; the seller is the one who must
schedule the appointments and is responsible for
seeing that the work is done.
10. b The answer is Consumer Financial Protection Bureau. The Consumer Financial Protection Bureau’s goals are to provide easier-to-use
mortgage disclosure forms, improve consumer
understanding, aid in comparison shopping, and
prevent surprises at the closing table.
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240
Answer Key
Unit 10 Review Questions
1. c The answer is William J. Jones. It is best to
use an individual’s full first name (no nicknames)
and middle initial.
2. c The answer is both the listing agreement
and the sales contract. Even when a couple is
separated, the absent spouse may still have dower
or curtesy rights to the property (depending on
state law). The absent spouse will have to sign
an eventual sales contract, and having the signature on the listing agreement provides better
insurance that this will happen.
3. b The answer is 4092 Terrace Ct., Dallas, TX
75211. Street addresses do not qualify as legal
descriptions.
4. d The answer is should be signed by the parties and listed in paragraph 22 of the contract.
Because the addendum becomes part of the
contract, it must be signed by all parties. Paragraph 22 lists all addenda included as part of the
contract.
5. d The answer is freestanding workbench. Any
item that is permanently attached becomes part
of the real property. A freestanding item that
can be moved is considered personal property.
A buyer could make a contract contingent on
the seller leaving the workbench, but the seller
would have to agree.
6. b The answer is wall-to-wall carpet in bedroom. Wall-to-wall carpeting is installed and
becomes real property. If the buyer has any concerns about what items will convey, they should
be listed in the original offer to purchase.
7. c The answer is help either buyer or seller
understand the financial impact of default.
When either the seller or buyer is considering
defaulting on the contract, a careful reading of
the default remedy clause can show the monetary
consequences of such a decision.
8. c The answer is the property title is free of
defects. A property title that is not free of defects
is said to have a “cloud on the title.”
9. d The answer is all of these. A cloud on the
title does not have to be a serious problem
and may include issues like the misspelling of
a grantor’s name, an incorrect date, or a slight
error in the legal description.
10. c The answer is signatures by electronic means
are as binding as handwritten ones. The UETA
does not require electronic signatures. To use
electronic signatures in a real estate transaction
in Texas, both parties must agree to it in an electronic consent form.
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Index
A
abstract of title 168
acceleration clause 134
acceptance 45, 95
accessibility 59
accretion 76
acknowledgment 158
actual notice 167
addendum 107, 124, 218
adjustable-rate mortgages (ARMs) 141
ad valorem tax 72
adverse possession 163, 172
affidavit of title 201
air rights 21
alienation clause 135
amendment 106, 121
American Land Title Association (ALTA) 170
amortized loan 140
annexation 24
annual fuel utilization efficiency (AFUE) 79
annual percentage rate (APR) 148
anticipatory breach 108
appraisal 177
appurtenance 20
area preference 26
asbestos 119
assessments 35
assets 177
assignment 47
assume 135
attorney’s opinion of title 169
avulsion 76
B
balloon payment 140
bargain and sale deed 160
base lines 99
beneficiary 31
bilateral contract 44
breach of contract 48
bring down 201
Broker-Lawyer Committee 3
bundle of legal rights 19
buydown 143
buyer agency agreement 55
C
carbon monoxide (CO) 119
certificate of eligibility 147
certificate of reasonable value (CRV) 147
certificate of title 169
chain of title 168
chattel 22
clear title 193
closing 194, 203
closing agent 195, 203
Closing Disclosure 195, 209
cloud on the title 160
codicil 165
combined loan to value (CLTV) 71
commercial contracts 50
commingling 105
common elements 34
community property 31
computerized loan origination (CLO) 149,
208, 210
condemnation 68
condominium 33
conforming loans 144
consent 46
consideration 45, 157
construction loan 143
constructive notice 167
Consumer Financial Protection Bureau (CFPB)
207
Consumer Price Index (CPI) 62
contingencies 106, 113
contract 43
contract of sale 84
controlled business arrangement (CBA) 209
conventional loans 144
cooperative 35
co-ownership 28
corporation 32
cost approach 192
counteroffer 45, 95
covenants, conditions, and restrictions
(CC&Rs) 72
coverage 170
credit 195
report 177
score 149, 177
cross-hatch 94
curable breach 108
D
debit 195
Deceptive Trade Practices Act (DTPA) 14
deed 155
in lieu of foreclosure 137
of trust 133, 161
restrictions 72
Deficiency judgment 137
Department of Veterans Affairs (VA) 146, 207
depreciation 192
devise 164
disclosures 53, 105
discount point 132, 146
draws 143
E
earnest money 105
easement 72
appurtenant 72
by necessity 74
by prescription 74
in gross 73
Electronic Signatures in Global and National
Commerce Act (ESIGN) 218
eminent domain 68
encroachment 74
encumbrance 71
Equal Credit Opportunity Act (ECOA) 148
equitable right of redemption 137
equitable title 97
erosion 76
escheat 68
escrow closing 204
escrow or impound account 193
escrow procedure 204
estate at sufferance 57
estate at will 56
estate for years 56
estate from period to period 56
estate in land 68
exchange 49, 203
exclusive-agency listing 51
exclusive-right-to-sell listing 51
executed contract 44
executory contract 44, 61
express contract 44
F
face-to-face closing 203
Fannie Mae 139, 207
Farm Credit System (Farm Credit) 147
Farmer Mac 140, 148
Farm Service Agency (FSA) 147
Federal Emergency Management Agency
(FEMA) 193
Federal Finance Housing Agency (FHFA) 139
Federal Home Loan Bank (FHLB) 140
Federal Housing Administration (FHA) 145,
207
Federal Reserve System (the Fed) 138
fee simple 69
defeasible 69
determinable 69
subject to a condition subsequent 70
first mortgage or deed of trust 136
fixture 24
flood insurance 193
foreclosure 136
Freddie Mac 139, 207
freehold estates 68
future interest 70
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242
Index
G
general partnership 32
general warranty deed 159
Ginnie Mae 140, 207
government-sponsored enterprise (GSE) 139
grantee 155, 156
granting clause 157
grantor 155, 156
gross lease 60
ground lease 60
H
habendum clause 157
heirs 165
holographic will 165
home equity conversion mortgage (HECM)
141
home equity line of credit (HELOC) 71, 144
home equity loan 143
home inspection 116, 193
homeowners association (HOA) 34
homeowners insurance 193
homestead 71, 158
hypothecation 131
I
immobility 27
implied contract 44
impound or escrow account 135
improvements 26, 19
in arrears 132
income approach 192
indestructibility 27
index 141
indoor air quality (IAQ) 79
interest 132
interest-only mortgage 140
Internal Revenue Service (IRS) 205
intestate 164
involuntary alienation 162
J
joint tenancy 29
judicial foreclosure 136
M
manufactured housing 22
margin 141
marketable title 115, 168, 220
market value 192
mechanic’s lien 72
metes-and-bounds 98
mineral rights 76
mold 119
month-to-month tenancy 56
monuments 98
mortgage 131
lien 72
rate factor chart 141
servicing disclosure statement 209
mortgage insurance premium (MIP) 146, 152
multiple listing service (MLS) 51
N
negotiable instrument 131
net lease 60
net listing 51
net worth 177
nonconforming loans 144
nonhomogeneity 27
nonjudicial foreclosure 137
novation 47, 135
nuncupative will 165
O
offer 45
to purchase 84
offeree 45
offeror 45
oil and gas lease 60
open listing 51
options 61
owner disclosure requirements 9
ownership and use tests 205
K
kickback 209
kick-out clause 120
L
land 18
contract 62, 136
lead 77
lease 55
agreements 57
purchase 61
leasehold estate 56, 68
legal description 98
legally competent 46
lessee 55
lessor 55
letter of intent (LOI) 97
liabilities 177
license 74
lien 71
theory 131
life estate 70
limited liability company (LLC) 33
limited partnership 32
liquidated damages 108
lis pendens 72
listing agreements 50
littoral rights 75
Loan Estimate 177, 208
loan origination fee 132
loan-to-value ratio (LTV) 114, 144
lot and block 102
P
plat map 102
point of beginning (POB) 98
police power 67
possession 220
power of attorney 158
preapproval letter 104, 177
prepayment penalty 132
primary mortgage market 138
principal meridians 99
prior appropriation 76
priority 167
private mortgage insurance (PMI) 145
probate 165
promissory note 131
promulgate 4
proprietary lease 35
prorations 210
public records 166
pur autre vie 70
purchase-money mortgage (PMM) 143
Q
quitclaim deed 160
R
radon 119
ranges 99
rate cap 141
real estate 19
forms of ownership of 27
Real Estate Settlement Procedures Act
(RESPA) 148, 149, 207
real property 19
REALTORS® 3
reconveyance deed 161
recording 166
rectangular survey system 99
Regulation Z 148
release deed 134
remainder interest 70
rescission 48
reverse mortgage 141
reversionary interest 70
reversionary right 55
revocation 45
right of first refusal 59
right of survivorship 29
riparian rights 75
Rural Housing Service (RHS) 147
S
sale and leaseback 61
sales comparison approach 192
sandwich lease 60
satisfaction 134
scarcity 26
school section 101
seasonal energy efficiency ratio (SEER) 79
secondary mortgage market 139
second mortgage or deed of trust 136
section 101
security deposit 58
separate property 31
severalty 27
severance 24
package loan 143
paid outside of closing (POC) 209
partition 30
partnership 32
payment cap 141
percentage lease 60
permanence of investment 26
personal property 22
plants 24
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Index
short sale 126
signatures 106
situs 26
special warranty deed 159
statute of frauds 44, 96
statute of limitations 48
straight loan 140
subdivision plat 103
subject to 135
sublease 59
substantial compliance 108
subsurface rights 20
suit for specific performance 108
suit to quiet title 168
surface rights 20
survey 98
synthetic stucco 119
T
tacking 74
taxation 68
Taxpayer Relief Act of 1997 205
tenancy in common 28
testate 164
testator 164
Texas Real Estate Commission (TREC) 2
Texas Real Estate License Act (TRELA) 2
thrifts 138
time is of the essence 47
time-share 36
estate 36
use 36
title 20
insurance 170
search 168
tort 94
township 100
lines 100
tiers 100
trade fixture 25
transfer tax 161
trigger terms 148
tri-merge credit report 149, 177
trust 31
trustee 31
trustee’s deed 161
trustor 31
Truth in Lending Act (TILA) 148
U.S. Department of Agriculture 140
U.S. Department of Housing and Urban
Development (HUD) 140
usury 132
V
VA-guaranteed loan 146
valid contract 46
variable lease 60
verbal offers 216
voidable contract 46
void contract 46
voluntary alienation 155
W
walk-through 201
items 116
water rights 21
will 164
U
underground storage tanks (USTs) 117
underwriter 193
unenforceable contract 47
Uniform Electronic Transactions Act (UETA)
218
unilateral contract 44
243
Z
zero tolerance 207
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